Mortgage rates come down,
homeowners with a mortgage are, as a result, better off, companies’
borrowing costs drop and, thus, spending begins to revive: if we all
believe this, a rate cut can become a self-­fulfilling event. Quantitative
easing, unfortunately, doesn’t offer the same intuitive message: for
many, it sounds distinctly suspect, has no personal relevance and,
thus, makes little difference to economic behaviour. And with
economic performance far worse than the protagonists of quantitative easing expected, the credibility of such esoteric measures has
steadily withered on the vine.
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One reason for increased scepticism relates to the impact of lower
long-­term interest rates – thanks to quantitative easing – on pension
fund deficits. As Charlie Bean, the Deputy Governor of the Bank of
England, explained in a May 2012 speech:
Quantitative easing does not inherently raise pension deficits. It all
depends on the initial position of the fund, with the movement in
liabilities and assets likely to be broadly comparable when a
scheme is fully funded.

…

This is a form of financial repression, a way of
ensuring that the government is able to rig credit markets to suit its
own aims even if the economy as a whole may perform less well as a
consequence.
Quantitative easing may originally have been designed to improve
economic performance but it has also allowed governments to
raise debt on the cheap. With economic stagnation, quantitative
easing has merely allowed governments to postpone the fiscal ‘day of
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reckoning’. And the longer stagnation persists, the worse the reckoning will eventually be. Quantitative easing is a useful way of
masking persistent increases in government debt, as if those increases
come at no economic cost. It is also, by implication, a useful way of
allowing governments to muscle their way to the front of the credit
queue: with the value of government bonds in effect ‘ring-­fenced’ by
the actions of central banks, quantitative easing in a risk-­averse
world will only encourage more and more investors to invest in
government bonds.

…

So if a fund starts off relatively ‘asset poor’, the sponsors will
now find it more costly to acquire the assets to match its future
obligations . . . A corollary of this is that the cost of provisioning
against additional pension entitlements being accumulated by
currently serving staff unambiguously rises.6
This would, perhaps, be a small price to pay if, as a result of quantitative easing, the economy quickly recovered, allowing quantitative
easing to be reversed. In that case, bonds held by the central bank as
a result of quantitative easing would be sold back to the market,
yields would rise and the pressure on pension deficits would be alleviated. Yet this hasn’t happened. Compared with a typical period of
recession, during which interest rates fall rapidly only to rise swiftly
thereafter, the absence of meaningful recovery leaves pension funds
facing the prospect of permanently lower interest rates and, thus,
growing difficulties in meeting their obligations.

Instead, it sold some of the government bonds in its portfolio to raise the cash it needed; and, in the third quarter of 2008, it obtained a $300 billion loan from the Treasury Department.
Quantitative easing began near the end of 2008. From that point, the Fed began buying credit instruments from the banks and paying for them by depositing money (money freshly created for the purpose) into the accounts in which banks held their liquidity reserves at the Fed. As discussed in Chapter 1, those reserves had steadily dwindled to next to nothing by the time the crisis began. That suddenly changed. They jumped from $33 billion in mid-2008 to $860 billion by the end of that year. By September 2011 they had grown to $1.6 trillion.
Quantitative Easing: Round One
Quantitative easing is a euphemism for fiat money creation. The “quantity” referred to is the amount of fiat money in existence.

…

Currency manipulation, therefore, can be measured by the size of a country’s foreign exchange reserves.
The value of the currencies that are not pegged can be highly volatile. Moreover, short-term currency movements are notoriously difficult to predict.
Quantitative Easing and Asset Prices
The immediate effect of quantitative easing is to push interest rates down and to push stock prices and commodity prices up. As just mentioned, in a capitalist system, when a government borrowed money it pushed up interest rates. That is no longer necessarily the case. Today, interest rates are determined not only by the demand for money but also by the supply of money.
Consider the second round of quantitative easing. Between November 2010 and mid-2011, the Fed created $600 billion and used it to buy government bonds. That allowed the government to borrow money to finance its very large budget deficits without pushing up interest rates.

…

See also U.S. economy
Election of 2012, issues of government spending and indebtedness
Emotions, in Mitchell’s theory of business cycles
Energy and energy prices. See also Solar initiative, proposed
excluded from CPI
in New Great Depression
quantitative easing and
England
Equation of exchange
European Central Bank
Extended-baseline scenario, of Congressional Budget Office
Fannie Mae:
conservatorship of
credit creation and decline in liquidity reserves
quantitative easing and
U.S. debt guarantees and
FDIC
Federal Reserve. See also Quantitative easing
commercial bank reserves (1945–2007)
end of gold standard, creation of fiat money, and expansion of credit
policy actions regarding New Depression
Federal Reserve Act of 1913
Fiat money:
end of gold standard and creation of
government deficit in 2013 and 2014 and
Fiat Money Inflation in France (White)
Financial sector:
debt and
lack of liquidity reserve requirements and credit expansion
Fiscal stimulus, needed with additional quantitative easing
Fisher, Irving
theory of debt-deflation
Fixed-interest-rate debt, in diversified portfolio
Flow of Funds Accounts of the United States
Food prices:
deflation and
excluded from CPI
quantitative easing and
Foreign causes, of credit expansion
Bernanke’s global savings glut theory and
central banks’ creation of fiat money and foreign exchange reserves
possibility of end to China’s buying of U.S. debt
Foreign exchange reserves.

A few key further points in the literature are introduced in an appendix to this chapter (grouped with other appendices at the end of the book), which gives a flavor of some of the issues that need to be taken into account.
QUANTITATIVE EASING
We now turn to alternative approaches that central banks have adopted to deal with the zero bound, short of negative rates. This section deals with the policies that the monetary authorities actually used during the financial crisis, namely, quantitative easing (QE) and forward guidance. Our purpose is to ask to what extent these various alternatives obviate the need for negative interest rate policy, or at least mitigate it to a large extent.
Since the financial crisis of 2008, most advanced-country central banks, including the Federal Reserve, the ECB, the Bank of England, and the Bank of Japan, have engaged in massive and aggressive quantitative easing. The scale of the interventions has been extraordinary. The Federal Reserve’s balance sheet rose from around $700 billion at the outset of the financial crisis to a peak of more than $4 trillion and roughly 25% of GDP.

…

Some have argued that the zero bound hasn’t really turned out to be all that important, because central banks have found pretty good ways to get around it, using unconventional tools such as “forward guidance” and “quantitative easing.” The first involves telling investors that the monetary authorities intend to elevate inflation in the future, even if they cannot do it now. When it works, forward guidance succeeds in bringing down the real interest rate, even if the nominal interest rate is stuck at zero, since of course the real interest rate is the nominal interest rate minus the expected rate of inflation. A second idea is quantitative easing (QE). We discuss QE in much greater detail later in this chapter, but essentially it involves using short-term central bank debt to buy long-term assets, such as government debt, thereby bringing long-term government interest rates down.

…

And the Bank of Japan’s QE program has already reached 70% of GDP, proportionately far greater than in the United States. And if it maintains its current pace, the Bank of Japan’s QE program is on track to hit the 100% of GDP mark within 2 years.
Quantitative easing has been the focus of extensive recent empirical research, though subject to the major constraint that experience so far has been limited.21 We will turn to this research shortly. In a nutshell, much of it basically constitutes event studies that look at the impact of quantitative easing announcements on market interest rates. There is almost certainly a transitory effect (even when the announcements are partly anticipated). But it is hard to know how long lasting the effects have been, basically because of the strong downward trend in long-term real interest rates after the financial crisis, a trend that seems to have its roots in many factors other than just central bank policy.

When these factors finally did converge, in 2010, the result would be the international monetary equivalent of a tsunami.
CHAPTER 6
Currency War III (2010–)
“The purpose . . . is not to push the dollar down. This should not be regarded as some sort of chapter in a currency war.”
Janet Yellen,
Vice Chair of the Federal Reserve,
commenting on quantitative easing,
November 16, 2010
“Quantitative easing also works through exchange rates.... The Fed could engage in much more aggressive quantitative easing . . . to further lower . . . the dollar.”
Christina D. Romer,
former Chair of the Council of Economic Advisers,
commenting on quantitative easing,
February 27, 2011
Three supercurrencies—the dollar, the euro and the yuan—issued by the three largest economies in the world—the United States, the European Union and the People’s Republic of China—are the superpowers in a new currency war, Currency War III, which began in 2010 as a consequence of the 2007 depression and whose dimensions and consequences are just now coming into focus.

…

Like winners in many wars throughout history, the United States had a secret weapon. That financial weapon was what went by the ungainly name “quantitative easing,” or QE, which essentially consists of increasing the money supply to inflate asset prices. As in 1971, the United States was acting unilaterally to weaken the dollar through inflation. QE was a policy bomb dropped on the global economy in 2009, and its successor, promptly dubbed QE2, was dropped in late 2010. The impact on the world monetary system was swift and effective. By using quantitative easing to generate inflation abroad, the United States was increasing the cost structure of almost every major exporting nation and fast-growing emerging economy in the world all at once.
Quantitative easing in its simplest form is just printing money. To create money from thin air, the Federal Reserve buys Treasury debt securities from a select group of banks called primary dealers.

…

By buying intermediate-term debt, the Fed could provide lower interest rates for home buyers and corporate borrowers to hopefully stimulate more economic activity. At least, this was the conventional theory.
In a globalized world, however, exchange rates act like a water-slide to move the effect of interest rates around quickly. Quantitative easing could be used by the Fed not just to ease financial conditions in the United States but also in China. It was the perfect currency war weapon and the Fed knew it. Quantitative easing worked because of the yuan-dollar peg maintained by the People’s Bank of China. As the Fed printed more money in its QE programs, much of that money found its way to China in the form of trade surpluses or hot money inflows looking for higher profits than were available in the United States. Once the dollars got to China, they were soaked up by the central bank in exchange for newly printed yuan.

British inflation has been by far the highest of the major European economies, and the Bank of England acknowledges that its quantitative easing policy has contributed. Europe had begun to notice Britain’s quantitative easing – but as an example to avoid, rather than to follow.
Professor Werner’s view
With no consensus among British economists about QE, who better to consult than the person who coined the term in the first place? Richard Werner, an expert on Japan, now of Southampton University, came up with the name in 1994. He has an unexpected perspective. He believes the whole QE exercise in Britain, as it was in Japan, is a ‘sham’, and isn’t really QE at all. ‘The Bank has dug a PR hole for itself with quantitative easing. I don’t know why they are using my expression,’ he tells me.
His ‘expression’ arises from a translation of a specific Japanese term, ryoteki kanwa, which he devised a couple of decades ago to shine a light on the inadequacies of the sluggish policies of the Bank of Japan.

…

Behind the imposing façade that glowers over Threadneedle Street, the Bank was preparing an experiment in ‘financial repression’, an experiment that was to test the balance between credibility and calamity. It was called quantitative easing.
Every schoolchild is familiar with ‘The Magic Penny’, the morning assembly song:
It’s just like a magic penny,
Hold it tight and you won’t have any.
Lend it, spend it, and you’ll have so many,
They’ll all roll over the floor.
Only in Britain could there be a ubiquitous children’s song that invokes the concept of the velocity of circulation of money. After all, it was in Britain that David Hume and John Stuart Mill developed the quantity theory of money, the classical basis for modern monetarism. So it is entirely appropriate that Britain is currently conducting the world’s biggest experiment in the creation of magic money. Quantitative easing (QE), as it is officially known – or ‘printing money’ as it has been more colloquially described – has seen a flood of magic pennies wash through Britain.

…

In January of that year, he regaled me with the finer details of Dutch economist Willem Buiter’s blog, and with his own appreciation of the difference between quantitative easing and qualitative easing. The former referred to the sheer amount of buying the central bank could do, the latter concerned an attempt to lower interest rates in specific markets, such as mortgage debt and corporate credit.
So this was a policy initiated and decided upon by the Bank, but with considerable input from the government. At the top of the Treasury the assumption was that the structure created would be used, as was the case in the USA, to buy a wide range of commercial, government and mortgage debt, but that operational decisions regarding such purchases would be left to the Bank.
And so, on 5 March 2009, quantitative easing was launched in Britain, accompanied by a cut in the base rate from 1 per cent to an unprecedented 0.5 per cent.

They are taught in central banking kindergarten never, ever to lose control of their balance sheet because that might cost them control of bank reserves and the money supply.
That said, the Fed did lose control of its balance sheet somewhat when it instituted “QE3” in September 2012. This brings us to . . .
VARIETIES OF QUANTITATIVE EASING
The Fed’s favorite unconventional weapon has been quantitative easing (QE), a term that encompasses a variety of ways to use the central bank’s balance sheet to improve financial conditions. Since the Fed has deployed this weapon multiple times and in several different ways, we need to spend a little time on it.
Since quantitative easing can take many forms, table 9.1 offers a simple two-by-two taxonomy. Quantitative easing operations might alter either the composition of the central bank’s balance sheet (the left-hand column) or the size (the right-hand column). The assets that the central bank purchases to do so can be either government securities (or Treasuries, the top row) or private-sector securities (the bottom row).* And, of course, many specific assets fall under the general term private-sector securities.

…

.*
The QE0 in the lower left cell of table 9.1 refers to several early episodes of quantitative easing—so early, in fact, that no one called them QE at the time. Most prominently, we saw that the Fed began buying commercial paper (CP) in October 2008 in order to breathe life into the moribund CP market. QE0 was clearly aimed at spreads—specifically, at the spread of CP over T-bills. This emergency operation constituted QE because the Fed both changed its balance sheet and increased bank reserves by buying private-sector assets.
QE1, the Fed’s massive purchases of Fannie Mae and Freddie Mac bonds and MBS between late November 2008 and March 2010, was a much bigger deal, quantitatively. That’s when the term “quantitative easing,” a Japanese coinage, started to be used in the United States. But what we now call QE1 also included purchases of $300 billion worth of Treasuries (upper right cell).

…

Like the CP program, the large-scale MBS purchases from 2008 to 2010 had a clear purpose: in this case, to reduce the spreads of MBS over Treasuries. And it worked. QE3 in late 2012 was essentially a repeat of the MBS part of QE1.
QUANTITATIVE EASING
A central bank normally eases monetary policy by reducing overnight interest rates—in the United States, that’s the federal funds rate. But what happens if the bank cuts its policy interest rate all the way to zero—or virtually to zero, as the Fed did in December 2008—and the economy still needs more stimulus? Does the central bank shutter its doors and take a long vacation? Or does it try something else?
Starting with the Bank of Japan in the 1990s, a number of central banks, prominently including the Fed, have resorted to some form of quantitative easing. The name derives from the idea that a standard easing of monetary policy works on price—on the cost of borrowing money.

As the economy lost 2.1 million construction jobs during the recession, such an upturn could add several hundred thousand jobs.
As a result of increasing consumption, robust business investment, and a delayed housing recovery, the odds are high that the economy’s growth rate will rebound to the 3.0–4.0 percent range by the first half of 2011. In such a scenario, quantitative easing will probably end in June 2011.
The Fed’s policy will also force other countries to pursue expansionary monetary policies in order to prevent their own currencies from appreciating excessively. Japan has engaged in currency market intervention and announced its own quantitative easing program to stem the appreciation of the yen. Developing countries in both East Asia and Latin America are engaging in currency intervention that could nurture more domestic monetary growth. The European currency has suffered from investor concerns about the debt servicing problems of peripheral countries such as Greece, Ireland, and Portugal.

…

Since Japan’s economy remained weak over the ensuing dozen years and politicians more or less consistently demanded greater accommodation, the BOJ’s determination not to be pushed around translated into chronically and inappropriately tight monetary policy. Thus, the BOJ, which pioneered quantitative easing in the early 2000s, never employed those unconventional methods boldly enough to overcome the problem of declining prices. To the contrary, its spokesmen stated on several occasions that the agency had done all it possibly could and that deflation simply could not be defeated through monetary means—a notion eventually belied by the success of the United States, the United Kingdom, and other countries in using quantitative easing to combat intense disinflationary pressures in 2008 and 2009 (and again in late 2010 and 2011). It would be wrong to suggest that the BOJ did not loosen policy in reaction to the crisis.

…

The US corporate sector is also running a free cash flow surplus exceeding $755 billion. This number is unprecedented in the modern era, and explains why firms are boosting investment on productivity-enhancing technology. The great uncertainties in the US outlook center on public policy. As the unemployment rate remained at 9.6 percent during the fourth quarter of 2010, the Federal Reserve embarked upon a program of quantitative easing. The Fed pledged to purchase $600 billion of government securities in the eight months through June. Federal Reserve Chairman Ben Bernanke said that the policy would help to reduce long-term bond yields and bolster the equity market. Finance ministers in Brazil, China, and other developing countries said that the policy was designed to devalue the dollar. Several Republican economists warned that the policy could be inflationary.

Rethinking Capitalism: An Introduction Capitalism and its discontents
Rethinking economic policy
Beyond market failure: towards a new approach
Notes
2. The Failure of Austerity: Rethinking Fiscal Policy Introduction
‘Deficits saved the world’
The fiscal retreat and the monetary plunge
A balanced budget or a balanced economy?
Notes
3. Understanding Money and Macroeconomic Policy Introduction
The orthodox view: exogenous money
Endogenous money and modern money theory
Money and monetary policy
Quantitative easing
Implications for the euro zone: the re-integration of money and fiscal policy
Conclusion
Notes
4. The Costs of Short-termism Introduction
The literature on short-termism
Empirical evidence of short-termism
Policy implications
Notes
5. Innovative Enterprise and the Theory of the Firm Introduction: what makes capitalism productive?
The neoclassical theory of the unproductive firm
The Marxian theory of the productive firm
The theory of innovative enterprise
The integration of theory and history
Notes
6.

…

Source: National Institute of Economic and Social Research, NIESR Monthly Estimates of GDP, 7th October, 2014, London, 2014, p. 1, http://www.niesr.ac.uk/sites/default/files/publications/gdp1014.pdf (accessed 12 April 2016).
Underpinning this weak growth pattern has been a dramatic collapse in private sector investment. Investment as a proportion of GDP had already been falling throughout the previous period of growth (see Figure 6). Since 2008 this has occurred despite the unprecedented persistence of near-zero real interest rates, bolstered in most of the major developed economies by successive rounds of ‘quantitative easing’, through which central banks have sought to increase the money supply and stimulate demand. Yet they have barely succeeded, as continuing low inflation rates have revealed.
The decline in investment is also related to the marked ‘financialisation’ of the corporate sector. Over the past decade or so, an increasing percentage of corporate profits has been used for share buybacks and dividend payments rather than for reinvestment in productive capacity and innovation.

SIX Ben Bernanke’s Crony Credit
SEVEN What the Supply-Siders and Hillary Clinton Sadly Have in Common
EIGHT Why “Senator Warren Buffett” Would Be a Credit-Destroying Investor
NINE The Credit Implications of the Fracking Boom
TEN Conclusion: Sorry Keynesians and Supply-Siders, Government Is Always a Credit-Shrinking Tax
PART TWO: BANKING
ELEVEN NetJets Doesn’t Multiply Airplanes, and Banks Don’t Multiply Money and Credit
TWELVE Good Businesses Never Run Out of Money, and Neither Do Well-Run Banks
THIRTEEN Do We Even Need Banks?
FOURTEEN The Housing Boom Was Not a Consequence of “Easy Credit”
FIFTEEN Conclusion: Why Washington and Wall Street Are Better Off Living Apart
PART THREE: THE FED
SIXTEEN Baltimore and the Money Supply Myth
SEVENTEEN Quantitative Easing Didn’t Stimulate the Economy, Nor Did It Create a Stock-Market Boom
EIGHTEEN The Fed Has a Theory, and It Is 100 Percent Bogus
NINETEEN Do We Really Need the Fed?
TWENTY End the Fed? For Sure, But Don’t Expect Nirvana
TWENTY-ONE Conclusion: The Robot Will Be the Biggest Job Creator in World History
Notes
Index
FOREWORD
Rob Arnott
AS YOU READ this volume, prepare to be surprised.

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But not only is Congress incapable of investing us to prosperity (remember, Congress never “fires” or ceases funding its Brady Hoke and Webvan equivalents), it can only spend what it has taxed or borrowed from the real economy first. The Fed is no different. It can’t create credit as much as it can re-allocate it toward parts of the economy that it deems worthy. The problem is the Fed, like Congress, can’t do this effectively because there’s no market to discipline its failures. This truth will become even clearer in chapter 17, on “quantitative easing.”
Some will reply that the Fed can create money out of thin air. While that is true, the creation of money is in no way the creation of credit. The two are entirely different. While the Fed’s ability to control or direct the supply of dollars is vastly overstated, the Fed could drop trillions of dollars from the sky, and no new credit would be created. It would, at best, reduce the amount of credit—real resources—that the dollar can command.

…

No productive nation will ever lack money supply, simply because production itself is a magnet for money. Just as we don’t worry about where our shoes, socks, and T-shirts come from, it’s fair to say we needn’t worry about money either. So long as money has a legal, redeemable definition (and if it didn’t, markets would come up with a definition), let the markets provide the money supply much as they do so many other goods we desire.
CHAPTER SEVENTEEN
Quantitative Easing Didn’t Stimulate the Economy, Nor Did It Create a Stock-Market Boom
You cannot step into the same river twice.
—Heraclitus
IN THE FALL OF 2014, the price of oil began to decline with great haste. While a barrel sold for more than $100 as recently as the summer of 2014, the price had fallen to $54 by December.
As the Dallas Morning News reported about the oil-patch carnage, “Oil prices are at their lowest level in five years.

This net worth has come from the purchases of government bonds through issuing bank notes, and the purchase of government bonds through the creation of central bank reserves through the Quantitative Easing scheme. In effect, this £313 billion is seigniorage which has been earned from the creation of money, but which has only been recognised as a result of the fact that this reform does not require backing assets to be held against the state-issued currency (for the reasons discussed in Appendix III). We now need to complete our changes to the balance sheet of the Bank of England by converting the demand deposits of banks into state-issued currency held at the Bank of England.
Box 8.A - Dealing with the bonds purchased through Quantitative EasingQuantitative Easing was a scheme set up in response to the financial crisis. One effect of QE was to boost the broad money supply, or at least negate the contraction in the money supply which arose when banks stopped lending but people continued paying down their debts.

…

More recently reserves have been injected through Quantitative Easing.
How commercial banks acquire central bank reserves
Ultimately, commercial banks need to acquire central bank reserves in order to settle net transactions with other banks. These net ‘settlement obligations’ arise when payments by customers of one bank to another are greater than the payments coming in the opposite direction. Banks may obtain reserves in one of three ways:
a) From the central bank
The central bank retains a monopoly on the production of central bank reserves. Therefore ultimately all central bank reserves initially come from the central bank. The central bank can inject these reserves into the system through a variety of channels, including through open market operations and quantitative easing. Here we will restrict ourselves to cases where the central bank lends reserves directly to commercial banks, which it may do in one of three ways:
Long term lending: Before the financial crisis the Bank of England ran what was known as a ‘reserves averaging scheme’.

…

When the central bank lowers the interest rate in response to recessionary conditions it benefits borrowers at the expense of savers. Pension funds in particular may suffer: lower interest rates increase the net present value of future liabilities, increasing the need for higher current fund contributions. Financial crises may also lead to unorthodox monetary policy (such as Quantitative Easing). Because quantitative easing pushes up the price of bonds it also lowers their yield, again increasing required contributions to pension funds.
Furthermore by decreasing the yield on bonds, QE increases the desirability of other assets, pushing up their prices. This can have long run effects. By purchasing assets the central bank may prevent prices from falling, and so ‘set a floor’ under their price, implicitly guaranteeing prices and legitimising prior investment decisions.

It focused exclusively on inflation—after all, that was its single mandate—and for a long time it continued to use as an indicator of its monetary stance (whether monetary policy was loose or tight) the rate of growth of the money supply, a holdover from the days when monetarism reigned king.
QUANTITATIVE EASING
When the Federal Reserve put interest rates down to zero—and still the economy did not recover—it felt it could and should do more. One idea was to purchase long-term bonds, driving down the long-term interest rates and providing more liquidity to the economy. This was called quantitative easing. The ECB was slow to introduce quantitative easing. It did so long after the United States, and even after Japan. Even as it undertook QE, the ECB may not have grasped why quantitative easing had such a limited effect in the United States—and why therefore the benefits would likely be still weaker in Europe. The problem in quantitative easing in the United States from 2009 to 2011 was that the money that was created wasn’t going where it was needed and where the Fed wanted it to go—to increase spending in the United States on goods and services.

…

Rewriting the Rules of the American Economy.
11 There is no general theory that argues the optimal response to the higher oil price should be that the demand for all nontraded goods should be lowered so that a particular index, the weighted average price, should be unchanged.
12 Indeed, as we have noted elsewhere, the ECB, worried about inflation, actually increased interest rates twice in 2011.
13 See chapter 4 for a discussion of competitive devaluation.
14 See Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, NJ: Princeton University Press, 1963).
15 The rate itself was determined mechanically—the rate of growth of the real economy.
16 Japan began its quantitative easing in earnest in 2011, buying hundreds of billions of dollars’ worth of bonds since then. The United States’ quantitative easing, which was even larger (though not relative to the size of its economy), began in 2008 and eventually entailed buying trillions of dollars’ worth of bonds. The Bank of England’s somewhat smaller program ran from 2009 to 2012. The theory behind QE is discussed at greater length at the end of this chapter.
17 This presumes that the local banks have the capacity to lend.

These actions, however, only served to pass the buck to somebody else. No one would admit such a thing – no one, apparently, was in the business of pursuing 1930s-style ‘beggar-thy-neighbour’ currency devaluations – yet as one central bank after another fired up its printing presses, it became increasingly difficult to think of quantitative easing in any other way. Admittedly, central banks tried their hardest to explain the domestic channels through which quantitative easing was supposed to work – the central bank would purchase existing government debt from investors using newly printed money with the aim of lowering yields, encouraging investors to switch into riskier assets like equities, which would then rise in value, signalling to companies that they should raise funds via the capital markets in order to increase capital spending – but the evidence was mostly unconvincing.

…

While not all people’s coins are being clipped simultaneously, some people’s coins are being clipped repeatedly. The economic and political consequences have not been fully thought through.
Among the ‘winners’ in a world of negative interest rates and quantitative easing are, most obviously, governments themselves. Lower borrowing costs enable governments more easily to meet their fiscal ambitions without having to make painful political decisions regarding spending programmes or tax rates. Other winners include those who have large holdings of financial wealth in the form of equities, government bonds or corporate debt. Quantitative easing is designed to increase the value of such assets, making the world’s financial plutocrats even more plutocratic. Then there are the providers of high-yield products who are likely to do well selling (or perhaps mis-selling) their products to a public too often unwilling or unable to recognize the risks involved.

…

True, the value of their financial assets initially fell a long way: in the initial stages of the global financial crisis, equities fell much further than housing. Yet the rich had two advantages. First, relative to their assets, they had a lot less debt and so, even as their assets fell in value, they were under no threat of finding themselves financially under the water. Second, they proved to be major beneficiaries of quantitative easing – the supposedly magical monetary medicine where, in effect, a central bank purchases financial assets in a bid to drive their price higher, in the hope that households and companies will spend more. The S&P 500 index peaked before the global financial crisis at 1,557. It then plummeted to a low of 683. A handful of years later – partly a response to sustained pump-priming from the Federal Reserve – the index had jumped to a new high of 2,270.

pages: 182words: 53,802

The Production of Money: How to Break the Power of Banks
by
Ann Pettifor

Central banks massively expanded their balance sheets by buying up or lending financial and corporate assets (securities) from capital markets, and crediting the accounts of the sellers. In this way the Federal Reserve has added $4.5 trillion to its balance sheet. The Bank of England’s balance sheet is bigger, relative to UK gross domestic product, than ever throughout its long history. But while quantitative easing (QE) may have stabilised the financial system, it inflated the value of assets like property – owned on the whole, by the more affluent. As such, QE contributed to rising inequality and to the political and social instability associated with it. So expanding QE further is probably not politically feasible.
Even while monetary policy was loosened, economic recovery stalled or slowed because governments simultaneously tightened fiscal policy.

…

Andy Haldane, responsible for Financial Stability at the Bank of England, argued once that even if bankers were to compensate society for the losses endured, ‘it is clear that banks would not have deep enough pockets to foot this bill.’8
Despite massive bailouts by taxpayer-backed central banks, it is my contention that, even as I write in 2016, global banks are still effectively insolvent. Government guarantees, cheap finance and quantitative easing, coupled with the manipulation of balance sheets, are all that appear to stand between today’s ‘too big to fail’ banks and insolvency.
The deregulated financial system – and liquidity
Under our deregulated financial system, and despite the Great Financial Crisis of 2007–09, commercial bankers can create credit or liquidity (i.e. assets that can easily and readily be turned into cash) effectively without limit, and with few regulatory constraints.

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The nationalised Bank of England, the US Federal Reserve as well as the free-standing European Central Bank – all ultimately backed by taxpayers – have, since August 2007, provided the world’s global banks and private financial markets with guarantees against losses, with historically low rates of interest on their borrowing, and with cheap and easy liquidity by way of monetary operations known as quantitative easing. (QE is the process whereby central banks purchase government debt or bonds from capital markets and place the bonds on their balance sheets. This cuts the number of bonds on the market, and because there is demand for ‘safe’ government bonds, the ‘price’ of these bonds rises, while simultaneously the ‘yield’ – comparable to the rate of interest – falls. This action helps bring down interest rates on government debt, but also on interest rates across the spectrum of lending.)

It could be a funding problem, in which the US Treasury was unable to raise money on reasonable terms. Or it could result from a plunge in the dollar, leading to inflationary fears. Indeed, quantitative easing could go horribly wrong, as it did in the Weimar Republic. Suddenly, all the newly created money (much of which is sitting idly in the banking system) could wash back into the global economy, driving up prices.
Remember also that Western countries have used up a lot of their policy options. In the middle of 2011, interest rates were 1 per cent or below almost across the board. Further fiscal stimulus looked unlikely. And the potential impact of quantitative easing was far from clear.
In a speech in October 2010, Mervyn King, the governor of the Bank of England, called for a ‘grand bargain’ between the major players in the world economy.8 ‘The risk is that unless agreement on a common path of adjustment is reached, conflicting policies will result in an undesirably low level of world output, with all countries worse off as a result,’ he said.

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Gold is no one else’s liability; you can own it outright. Paper or electronic money is always a claim on someone else, whether a bank or a government. Modern money is debt and debt is money.
It is no coincidence that debt levels have exploded in the last forty years, culminating in the credit crisis of 2007 and 2008 from which the world is still recovering. In response to that crisis, new money was created via a tactic called quantitative easing (QE) – central bankers created money to buy government bonds (and other assets). The creation of money to finance government deficits is something that would have horrified the sound-money men of Bryan’s era. But such tactics are hardly a surprise, now that governments and not just farmers have huge debts. The philosopher John Stuart Mill warned in The Principles of Political Economy, published in 1848, that ‘the issuers may have, and in the case of a government paper always have, a direct interest in lowering the value of the currency, because it is the medium in which their own debts are computed’.

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So a bit like the porridge of Goldilocks, we want a money supply that is not too hot (commonplace), not too cold (scarce) but ‘just right’. Mankind has tried to find that balance in many different ways.
Some politicians and voters have been tempted by money creation in the same way that the French regent was tempted by John Law. Modern economists mostly agree that monetary stimulus can be effective in reviving the economy. The twenty-first-century tactic of quantitative easing is a high-tech version of the same theory.
Imagine, however, that you are a creditor or a merchant selling goods. Your debtor or customer offers to pay you back, not in pounds or dollars, but in Monopoly money. You might not regard this as payment at all. The fundamental worry of creditors is that governments can issue as much money as they like. Indeed, the concept is built into the rules of the Monopoly board game.

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The Corruption of Capitalism: Why Rentiers Thrive and Work Does Not Pay
by
Guy Standing

Mark Carney was prised from being head of Canada’s central bank at vast public expense. Whatever his qualities, this was unprecedented. Could one imagine a foreigner being appointed to run the US Federal Reserve or France’s national bank?
A second feature has been the resort by governments and central banks since the crash to inject cash into the banking system, to bail out failing banks and to pump up the money supply to stimulate growth via ‘quantitative easing’. QE is discussed later in this chapter. Here it is enough to recall the self-serving statement used to justify the bailouts, that the banks were ‘too big to fail’. The cringing justification for giving them vast amounts of public money was that if they went bankrupt due to their recklessness the contagion effects would have sunk the whole economy. So their owners and managers were helped to restore their lavish earnings.

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QE AND CHEAP MONEY
‘Bankers have been the biggest beneficiaries, with their twenty- or thirty-times leveraged balance sheets. Asset managers and hedge funds have benefited, too. Owners of property have made out like bandits. In fact, anyone with assets has grown much richer. All of us who work in financial markets owe a debt to QE.’
Paul Marshall, chairman of Marshall Wace, a London-based hedge fund
The clunky term quantitative easing, QE, entered the popular lexicon in the wake of the 2008 financial crash. It involves creating money for banks and other financial intermediaries to lend to companies and consumers. The central bank does this by buying government bonds and other debt from the banking sector, giving it low-cost funds to finance investment.
All the major central banks – the US Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan – have operated QE and related ‘cheap money’ policies.

Nominal growth equals real growth plus inflation. Since real growth is anemic, the central banks must cause inflation to have any hope of increasing nominal growth and reducing these debt-to-GDP ratios. When policy interest-rate cuts are no longer possible because the rates are effectively zero, quantitative easing, designed in part to import inflation through currency devaluation, is the central bankers’ preferred technique.
The Bank of England (BOE) has engaged in four rounds of quantitative easing (QE), beginning in March 2009. Subsequent rounds were launched in October 2011, February 2012, and July 2012. Increased asset purchases have ceased for the time being, but the BOE’s near-zero-interest-rate policy has continued. The BOE is refreshingly candid about the fact that it is targeting nominal rather than real growth, although it hopes that real growth might be a by-product.

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The European monetary standard prior to Charlemagne was a gold sou, derived from solidus, a Byzantine Roman coin introduced by Emperor Constantine I in A.D. 312. Gold had been supplied to the Roman Empire since ancient times from sources near the Upper Nile and Anatolia. However, Islam’s rise in the seventh century, and losses in Italy to the Byzantine Empire, cut off trade routes between East and West. This resulted in a gold shortage and tight monetary conditions in Charlemagne’s western empire. He engaged in an early form of quantitative easing by switching to a silver standard, since silver was far more plentiful than gold in the West. He also created a single currency, the livre carolinienne, equal to a pound of silver, as a measure of weight and money, and the coin of the realm was the denire, equal to one-twentieth of a sou. With the increased money supply and standardized coinage, along with other reforms, trade and commerce thrived in the Frankish Empire.

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Both countries are out on a limb, with printing presses, insufficient gold, no monetary allies, and no Plan B.
Japan and the U.K. are part of a global monetary experiment orchestrated by the U.S. Federal Reserve and articulated by former Fed chairman Ben Bernanke in two speeches, one given in Tokyo on October 14, 2012, and one given in London on March 25, 2013. In his 2012 Tokyo speech, Bernanke stated that the United States would continue its loose monetary policy through quantitative easing for the foreseeable future. Trading partners therefore had two choices. They could peg their currencies to the dollar, which would cause inflation—exactly what the GCC was experiencing. Or, according to Bernanke, those trading partners could allow their currencies to appreciate—the desired outcome under his cheap-dollar policy—in which case their exports would suffer. For trading partners that complained that this was a Hobson’s choice between inflation and reduced exports, Bernanke explained that if the Fed did not ease, the result would be even worse for them: a collapsing U.S. economy that would hurt world demand as well as world trade and sink developed and emerging markets into a global depression.

There were two contrary responses in the form of letters to newspapers from my Keynesian friends Lord Richard Layard and Lord Robert Skidelsky, with many, many, more signatures for each. In the United States Paul Krugman was arguing strongly for a massive fiscal boost, while the New Classical economists of Chicago and Minnesota were skeptical of the need for, or the effectiveness of, any stimulus. Only among the central bankers of the United States and the United Kingdom was there agreement that the money supply had to be boosted by quantitative easing.
Four years later and with hindsight, we can see that the crisis was severe – one of the deepest ever. We also know that the recovery is fragile, at best, in the UK and the US, and non-existent in the eurozone. With the possibility that the recovery may be destabilized by the slightest wrong turn, now is an opportune time to reflect on what went wrong. The problem was not so much with the economy but more importantly with economics and economists.

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For its actual value is largely governed by the prevailing view as to what its value is expected to be.”2
The monetary authorities might try to pump more money into the system but people would prefer to leave the money idle, earning zero interest, than exchange it for bonds. There was a liquidity trap where the rate of interest reached a floor, and no further fall could be engineered by the monetary authorities. Recent policies of quantitative easing have seen Central Banks buying bonds and other assets on the open market to lower the rate of interest, both short term and long run. The short rate has reached a floor of below 0.5 percent and that is what a liquidity trap looks like.
The novelty of terms such as consumption function and the marginal propensity to consume attracted the younger generation of economists. These terms looked more scientific and in tune with the then fashionable psychology.

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The answer instead has been to allow Central Banks to buy bonds aggressively to pump money into the system. This policy originates from Milton Friedman and Anna Schwartz’s Monetary History of the United States.9 They blamed the severity of the Great Depression on the Fed’s policy of restricting the money supply. Ben Bernanke, the Fed Chairman who studied the Great Depression as his Ph.D. topic, took the lesson to heart. The policy of quantitative easing has been the norm for five years in the US and the UK. Japan has also joined the ranks. The European Central Bank is also contemplating adopting this strategy as the rate of inflation has fallen below 1 percent in the eurozone area.
Keynes was skeptical about the efficacy of monetary policy to stimulate the economy out of depression. But the British recovery during the mid-1930s was based on monetary policy rather than fiscal policy.

In the case of the US, Mr Haldane listed $3.8tn in money creation and $0.2tn in ‘collateral swaps’, both from the Federal Reserve. He also listed $2.1tn in ‘guarantees’, $3.7tn in ‘insurance’ and $0.7tn in ‘capital infusions’ (from the TARP), all of which came from the government. The total came to $10.5tn.
43. International Monetary Fund, Fiscal Monitor, April 2012, www.imf.org, Table 7.
44. Quantitative easing was first used by the Bank of Japan in 2001. See http://en.wikipedia.org/wiki/Quantitative_easing.
45. Bank for International Settlements, 83rd Annual Report 2013, Basel, 23 June 2013, http://www.bis.org/publ/arpdf/ar2013e.pdf, Figure VI.3, p. 69.
46. Fiscal data are from the IMF’s World Economic Outlook database, except where otherwise indicated.
47. Data on discretionary fiscal stimulus are taken from IMF, Fiscal Monitor, November 2010, www.imf.org, Box 1.1.

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In essence, then, the developed countries’ most important central banks offered free or nearly free money to their banks from 2009 or, in some cases, from slightly earlier than that. It was little surprise that this official largesse to banks, not matched by comparable largesse from banks to their own borrowers – indeed accompanied by foreclosures on a grand scale in some countries – became a source of significant popular resentment. In addition, central banks adopted a wide range of ‘unconventional’ policies, including, notably, the policy known as ‘quantitative easing’ – expansion of the monetary base and central-bank purchases of longer-term assets.44 Such unconventional policies were aimed at financing banks, lowering yields on government bonds, increasing the money supply and easing credit supply. In domestic currency, the balance sheet of the ECB increased roughly threefold between 2007 and mid-2012, before shrinking modestly, while that of the Federal Reserve rose three and a half times and that of the Bank of England more than fourfold between 2007 and early 2013.45 To take the most important example, the US monetary base rose by $2.8tn between August 2008 and November 2013 – a sum equal to 17 per cent of annualized US gross domestic product in the third quarter of 2013.

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After the crisis, much of the world found itself with close to zero nominal short rates. At that point, the debates revived. Both monetarists and most adherents of the contemporary orthodoxy argued that monetary policy could still work effectively, either by expanding the quantity of money or lowering the yield on other securities, particularly long-term bonds. One policy, it was thought, would achieve both those outcomes: quantitative easing, by which was meant the expansion of the monetary base. By using newly created central-bank money to buy bonds, the central bank could, it was believed, both expand the money supply and lower yields.
Figure 37 shows what happened to US M2, the broadest measure of money the Federal Reserve publishes, after 1980.46 M2 consists of currency held by the public, plus deposit liabilities of financial institutions principally belonging to households.

Now that the credit bubble has burst and banks and financials have imploded, what is next?
We have huge deflationary forces that up until recently were self-reinforcing. These forces were only mitigated by record government interventions with liquidity provisions, interest rate cuts, quantitative easing, and fiscal stimulus. Now we have two enormous forces struggling against each other: one deflationary—the economy and the financial system—and one reflationary—stimulus of various types. We haven’t got a clue how these will play out, and it’s rather difficult balancing them. Quantitative easing, probably the correct course for central banks, is a difficult beast to control if market psychology turns quickly or if the real economy improves faster than expected. Because timely exit strategies will be tricky to implement, it is likely that they will come too early or too late.

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However, this also makes alternatives more attractive. I am sure that one of these alternatives will indeed become very important fundamentally, but many will be bubbles.
When you mention the end of fiat money, what do you mean?
Regarding the end of fiat money, there is understandable concern about that concept. The global response to this crisis is massive reflation. Quantitative easing is now ubiquitous enough to be on CNN Headline News, whereas just two years ago, it was an arcane economics term. Quantitative easing is the budgetization of monetary policy—essentially printing money—and the examination of global central bank balance sheets confirms that it is global in scope and massive in scale. We all know that (1) money is ultimately a confidence trick, so policy credibility is very important; and (2) inflation unequivocally erodes savings and capital in the long term, which is one of the main reasons that price stability became such a focal point the past two decades and one of the standards for judging convergence.

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The Experiment started with Greenspan, who preemptively and aggressively cut interest rates to head off the looming recession/depression in 2001-2003. It was a real-time experiment; it had never been done before. From 2003 to 2007, it appeared to have worked as easy money helped fuel another leg to the property and asset boom. I underestimated the potency of easy money when asset deflation emerges, perhaps because there was still another asset to inflate: property (see Figure 2.2). The hyper-experiment today, which includes the use of quantitative easing (QE) and bailouts, is a renewed attempt to prevent a cascade of defaults and preempt a deepening recession and possibly a prolonged depression.
Figure 2.2 U.S. Home Prices and S&P 500 Index, 2000-2009
SOURCE: Bloomberg.
It is very important, however, not to neglect the role of fiscal policy. The conventional argument is that Greenspan’s monetary policy was too easy, which created conditions for the equity bubble of the mid-to late 1990s and the housing bubble of 2002-2007.

Unfortunately, the huge deficits we’ve run up since the last recession are very real bills that will need to be paid.
Central banks are running printing presses almost nonstop to kick-start economic growth. In the United States, the Fed calls this tactic “quantitative easing”—a fancy way of saying the Fed is finding ways to pour as much new money into the system as it can. Typically, the Fed sticks to using its control over short-term interest rates to help strengthen the economy. But with those interest rates already at zero, Bernanke and Co. have needed to reach further into their bag of tricks. Under its program of quantitative easing, the Fed is buying longer-term government bonds in an attempt to inject new life into the economy. It works like this: By buying up US Treasury bonds, the Fed is trying to bring down long-term interest rates.

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Federal Reserve chairman Alan Greenspan was spurred to hike interest rates by soaring oil prices, which were stirring inflation. Higher interest rates pricked the housing bubble, and the rest of the world was dragged down when the bubble burst.
The Fed’s new chairman, Ben Bernanke, appears to be undeterred by the policy failures of his predecessor. His efforts to stimulate economic growth with rock-bottom interest rates and trillion-dollar quantitative easing programs will prove just as unsuccessful as Greenspan’s attempts to keep the economy afloat. Bernanke believes that holding interest rates near zero will encourage Americans to spend money, particularly on new homes. But what’s holding back the housing market isn’t the cost of taking out a mortgage, but a lack of jobs and economic growth. And that has little to do with the Fed’s monetary policy.

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A lower rate of return on long-term government bonds, considered a relatively safe haven in times of financial uncertainty, makes other investments more attractive by comparison. Investors typically park huge sums of cash in long-term US bonds in an attempt to ride out a financial storm. By lowering the returns on those bonds, the Fed is trying to steer money into other parts of the financial system where it can do more good for the economy.
As part of its quantitative easing program, the Fed also entered the market for mortgage-backed securities. Buying these securities allows the Fed to effectively lower mortgage rates, which reduces borrowing costs for potential homeowners, a move the Fed hopes will help to stimulate the housing market.
By engineering a more modest return on government bonds, the Fed is also trying to curb the giant appetite for US dollars among global bond investors.

They also announced the second phase of their quantitative easing technique. Instead of just buying mortgage securities, they agreed to begin buying up to $300 billion of longer-term Treasury securities over the next six months. They split up this buying among Treasury securities ranging from a 2-year maturity to a 10-year maturity. This program of buying long-dated securities to try and force their yields down has become known as QE1 (quantitative easing 1). Although it was innovative, it was not only not a new idea, but had already been put into practice by the Japanese between 2001 and 2004. During this period, the Japanese central bank bought long-term Japanese bonds. Some have argued that this policy was successful in stimulating Japan’s output for a period of two and a half years.4
The quantitative easing in the United States continued further when on November 3, 2010, the Fed announced that it would purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.5 This was called QE2 (quantitative easing 2).

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This was another example of the Fed using unconventional measures to provide liquidity to the system, since banks were not funding the short-term borrowing needs of U.S. corporations.
On November 25, 2008, the Federal Reserve created the Term Asset-Backed Securities Lending Facility (TALF), which allowed the Fed to lend up to $200 billion on a nonrecourse basis to holders of AAA-rated asset-backed securities.
Quantitative Easing
On November 25, 2008, the Fed announced perhaps its most unusual program of quantitative easing.3 Rather than simply manipulate the short-term Fed Funds rate, the Federal Reserve announced that it would purchase directly mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae. This was the Fed’s second big innovation. With short-term interest rates already basically at zero and the economy still sputtering, the Fed decided to manipulate the long-term market for securities directly.

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Some have argued that this policy was successful in stimulating Japan’s output for a period of two and a half years.4
The quantitative easing in the United States continued further when on November 3, 2010, the Fed announced that it would purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.5 This was called QE2 (quantitative easing 2).
There have been both critics and supporters of the quantitative easing programs. Ultimately, it is hard to determine whether or not these policies helped stabilize the financial markets since there were so many other factors present. Also, it is impossible to do the counterfactual. That is, what would have happened had the Fed not engaged in these policies? Studies by researchers at the IMF believe that they did contribute to financial market stabilization.6
FIGURE N.3 shows the behavior of key interest rates after the QE1 and QE2 program announcements.

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Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America
by
Danielle Dimartino Booth

It took a few months, but the Fed’s mouth-to-mouth resuscitation brought gasping investment banks and hedge funds and giant corporations back to life. Wall Street rejoiced.
But the Fed’s academic models never addressed one basic question: What happens to everyone else?
In the decade following that fateful day, everyday Americans began to suffer the aftereffects of the Fed’s decision. By 2016, the interest rate still sat at the zero bound and the Fed’s balance sheet had ballooned to $4.5 trillion, thanks to the Fed’s “quantitative easing” (QE), the label given its continuing purchases of Treasuries and mortgage-backed securities.
To what end? All around are signs of an economy frozen in motion thanks to the Fed’s bizarre manipulations of monetary policy, all intended to keep the economy afloat.
The direct damage inflicted on our citizenry begins with our youngest minds and scales up to every living generation in our country’s midst.

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Nor do they include the impromptu meetings like the one that Bernanke held at Jackson Hole in August 2007. As hedge funds tanked and credit markets trembled, Bernanke pulled a handful of top Fed officials into an empty conference room to talk about a possible Fed response. In the room: Geithner, Governors Kohn and Warsh, Dudley, and board secretary Brian Madigan.
With these core supporters, Bernanke outlined his theories on the zero bound and quantitative easing. Geithner would later call the game plan the “Bernanke Doctrine.” (This meeting is absent from Bernanke’s memoir, perhaps because he knew it was less than kosher.) Though no action was taken at the time, substantive policy strategies were predetermined, to be fleshed out a year later at the Jackson Hole symposium in August 2008.
No record was made of the meeting. Fisher and Rosenblum were not made aware of this secret discussion—an example of how Fed officials sometimes skirt transparency policies when it suits them.

While QE can be branded ineffectual, for reasons outlined below, the assertion that the Fed’s QE will push America into another 1970s-like period of ever accelerating prices is ludicrous. Yet truth is not the currency in which the recalcitrant Right trades: terrifying impressions (that can be employed further to boost private appropriation of publically produced wealth) are!
Quantitative easing as the most complex form of wishful thinking
At the time of writing, the third round of quantitative easing, QE3, was in the air. It is worthwhile taking a look at what it means, because a great number of false accounts circulate whose profound error is particularly instructive regarding the nature of our Crisis.
According to the Fed’s own announcement, every month (until further notice) America’s central bank will be buying $40 billion of paper titles backed by mortgages (so-called mortgage backed securities, or MBS).

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Vandana Shiva, an Indian physicist and ecologist who directs the Research Foundation on Science, Technology and Ecology, offers a compelling explanation for the food crisis that had erupted in the developing nations just before the Crash of 2008. See Vandana Shiva (2005) Earth Democracy: Justice, sustainability, and peace, Cambridge, MA: South End Press.
5. Quantitative easing is usually referred to as a species of printing money. This is not strictly true. What the Fed is doing is purchasing from banks and other institutions all sorts of paper assets (US government bonds plus private companies’ bonds). It does this by creating overdraft facilities for these institutions, on which they can draw for the purposes of lending to others. But if these institutions do not lend to others (because they cannot find clients willing to borrow), the result is zilch. This is why I say that quantitative easing is an attempt to create money. The Fed’s tragedy is that it is trying to print money but finds it hard to succeed!
6. In Europe, politicians are even terrified of the bankers whose bacon they are still saving, daily, and to the tune of billions per month.
7.

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In the United States, the Obama administration, following the Republicans’ victory in the November mid-term elections of 2010, is effectively bamboozled. With the government no longer able to pump-prime the economy with fiscal stimuli, the lonely task of tilting at the slow-burning Crisis has fallen on Ben Bernanke’s Fed. So the Fed, unhappily, is still desperately trying to increase the quantity of money circulating in the American economy by buying hundreds of billions of dollars’ worth of paper assets (quantitative easing is the name of the game).5 Bernanke knows that this is far from an ideal situation, but is left with no choice at a time of stalemate between the White House and Congress.
In Europe, the Crisis has set in train centrifugal forces that are tearing the eurozone apart, setting the surplus economies, with Germany at the helm, against the stragglers, whose structural deficits cannot be cured, no matter how much belt-tightening goes on.

Recall that the wealthiest 1 percent of Americans own about 40 percent of the nation’s wealth, and the picture becomes even more disturbing.64
prop trading In proprietary trading, banks bet their own money for their own benefit, as opposed to making such trading only on behalf of their clients. It is supposed to be banned by the forthcoming Volcker rule.
quantitative easing (QE) An “unconventional” technique used by governments and central banks when interest rates are too low to go down any further, but the need for economic stimulus still exists. QE involves a government buying back its own bonds using money that doesn’t actually exist. It’s like borrowing money from somebody and then paying her back with a piece of paper on which you’ve written the word “Money”—and then, magically, it turns out that the piece of paper with “Money” on it is actually real money. Another way of describing quantitative easing would be if, when you look up your bank balance online, you had the further ability to add to it just by typing numbers on your keyboard.

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But these digital ones and zeros measure the value of our labor and define a large part of our being, not just externally in terms of the work we do and where we live and what we own, but in terms of what we think, how we see our interests, with whom we identify, how we define our goals and ambitions, and often, perhaps too often, even what we think of ourselves in our deepest and innermost private being. And yet they’re just ones and zeros. And these ones and zeros are willed into being by governments, which can create more of them just by running a printing press; in fact, thanks to the miracle of quantitative easing, they don’t even need to do that, but instead can merely announce that there is now more electronic money. We’re inclined to think of money as a physical thing, an object, but that’s not really what it is. Modern money is mainly an act of faith—an act of credit, of belief.
One of the lessons of the credit crunch was that this credit, this belief, can be vulnerable. A moment came when it wasn’t clear, even to people at the heart of the system—the high priesthood of money itself—that the ones and zeros were worth what they were supposed to be worth.

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Although much of the coverage of the stock market focuses on how the price of shares goes up and down, history shows that about half the value of stocks has always come from the dividends they pay.
dove A term often used in regard to inflation: an inflation dove is someone who thinks that the economy needs as much stimulus as it can get and that to raise interest rates would be a disaster. Inflation doves love quantitative easing and any other associated loose monetary policy. The opposite of a dove is a hawk.
downgrade When a ratings agency lowers its rating on the debt issued by a company or country, that is a downgrade. Ratings agencies do that because they think the bond has grown in risk. A downgrade can have important consequences, because some types of investors, such a municipalities and public pension funds, are by law allowed to invest only in specific grades of debt: if a bond is downgraded, that can mean that some investors have no choice but to sell their bonds.

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Rethinking the Economics of Land and Housing
by
Josh Ryan-Collins,
Toby Lloyd,
Laurie Macfarlane,
John Muellbauer

Net wealth – The balance of a household’s assets subtracted from its liabilities. For example, if a household has savings of £50,000, owns a home worth £250,000 and has mortgage and credit card debts of £100,000, its net wealth will be £200,000.
Property – In this book, property will be understood to refer to a spatially defined area of land and the structures on top of it that is legally owned by an individual or firm.
Quantitative easing – An unconventional form of monetary policy where a central bank creates new money electronically to buy financial assets like government bonds from commercial banks and other financial institutions.
Real estate – Property consisting of land or buildings.
Residential mortgage-backed security (RMBS) – A type of asset-backed security that is secured by a collection of domestic mortgages.
Section 106 – A section of the Town and Country Planning Act 1990 which allowed local planning authorities to enter into legally binding agreements with developers, with the latter having to provide certain public benefits as part of the development.

Here are the four most-touted pro-middle-class policies and the reasons why they won’t halt the current decline:
Stimulus. Though they quarrel over details, most economists agree that when recession strikes, government should rekindle the economy by adding money to it. Democrats prefer to do this through direct spending, Republicans through tax cuts. The Federal Reserve often plays along by lowering interest rates or printing money through a process called “quantitative easing.”
Such fiscal and monetary pump-priming often perks up the economy for a while, but it doesn’t fix the causes of middle-class decline. As we’re seeing nowadays, it’s easy for GDP and corporate profits to grow without more income flowing to the middle class.
Job creation. Listen to any politician and you’ll hear bold promises to spur job creation. The underlying premise is that more private sector jobs will save the middle class and that given enough incentives, profit-seeking entrepreneurs will create them.

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The International Monetary Fund has argued that other measures might work better.7
With regard to new money creation: from 2001 to 2008 (before the financial crisis), the average yearly increase in what the Federal Reserve calls M2 was $244 billion.8 I use this figure (which is adjusted to 2013 dollars) to calculate the low end of the range in figure 7.1. For the high end I use the average annual change in M2 from 2001 to 2013, which includes several years of “quantitative easing.” That figure, translated into 2013 dollars, is $323 billion. The middle figure is halfway between.
Intellectual-Property Protection
Intellectual property (IP) rights owned by private corporations include patents, copyrights, and trademarks granted and enforced by the federal government. Such property rights are enormously valuable. A recent study by the Department of Commerce found that IP-intensive industries account for about a third of US GDP.9 This is the reason why our government goes to such great lengths to protect IP, not only within the United States but worldwide.

It was clear that currencies had played an important role in the development of the crisis and in the ability of governments to withstand the squalls of the financial storm. The ease with which credit could be issued with paper money has already been observed. More paradoxically, the paper money which had been responsible in large part for the explosive increase in credit was now seen to provide the solution. It was in this period that the phrase ‘quantitative easing’ first entered into everyday speech, at least in the newspapers. If anything symbolized the power of the government to conjure money out of thin air it was quantitative easing. Quantitative easing (QE) was said to be ‘an ugly name for a simple idea’. Central banks ‘buy long-term government bonds with newly printed money’.56 The theory was that this purchase of government debt, by which the central bank was effectively printing money and lending it to its own government, would keep bond prices high.

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In his own words, very simply put, ‘A greater Quantity [of money] employs more People than a lesser Quantity.’13 Another central component of Law’s thinking was that more economic activity would lead to an export surplus. This latter conclusion has not been endorsed by modern economists, but Law’s suggestion that the level of output, or ‘trade’ in his terminology, was related to the quantity of money is an idea which has been persistently espoused by later economists. Indeed, the modern advocates of ‘quantitative easing’, whereby a central bank prints more money to sustain economic activity, are the intellectual descendants of John Law.
Unlike most gamblers, and even most monetary theorists, Law, by a series of improbable circumstances, managed to put his theories into practice on a national stage. He spent much of his late thirties and early forties travelling around the ‘principal cities of Italy’, where he continued ‘his speculations, playing at all sorts of games, betting, and engaging in the public funds and banks’.

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Tim Geithner was Obama’s Treasury Secretary, and coincidentally an alumnus of the same small elite New England university attended by Hank Paulson, Dartmouth College. A slick and committed public servant, he had earned plaudits from Britain’s Alistair Darling, who found him ‘unpretentious and easy going’, with a ‘quiet style’ which ‘belied a steely determination’.59 He and most of the other leading figures in both the United States and the West generally were committed to printing and spending large sums of money to avert recession. Such policies as quantitative easing and the running of enormous budget deficits could be applied only in a world which had been totally removed from the constraints imposed by a gold standard.
Central bankers like Bernanke remained committed to providing liquidity and supporting bond prices by means of printing more money. Some drastic spending cuts did occur in some countries in Europe such as Greece, Ireland and Portugal.

To be fair, the Fed has moved to some extent on the first bullet point above: under the deeply confusing name of “quantitative easing,” it has bought both longer-term government debt and mortgage-backed securities. But there has been no hint of Rooseveltian resolve to do whatever is necessary: rather than being aggressive and experimental, the Fed has tiptoed up to quantitative easing, doing it now and then when the economy looks especially weak, but quickly ending its efforts whenever the news picks up a bit.
Why has the Fed been so timid, given that its chairman’s own writings suggest that it should be doing much more? One answer may be that it has been intimidated by political pressure: Republicans in Congress went wild over quantitative easing, accusing Bernanke of “debasing the dollar”; Rick Perry, the governor of Texas, famously warned that something “ugly” might happen to Bernanke if he visited the Lone Star State.

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Meanwhile, actual investors seemed not at all worried: interest rates on long-term U.S. bonds were low by historical standards as Bowles and Simpson spoke, and proceeded to fall to record lows over the course of 2011.
Three other points are worth mentioning. First, in early 2011 alarmists had a favorite excuse for the apparent contradiction between their dire warnings of imminent catastrophe and the persistence of low interest rates: the Federal Reserve, they claimed, was keeping rates artificially low by buying debt under its program of “quantitative easing.” Rates would spike, they said, when that program ended in June. They didn’t.
Second, the preachers of imminent debt crisis claimed vindication in August 2011, when Standard & Poor’s, the rating agency, downgraded the U.S. government, taking away its AAA status. There were many pronouncements to the effect that “the market has spoken.” But it wasn’t the market that had spoken; it was just a rating agency—an agency that, like its peers, had given AAA ratings to many financial instruments that eventually turned into toxic waste.

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The sad irony is that back in 2000 Bernanke criticized the Bank of Japan for essentially having the same attitude, of being unwilling to “try anything that isn’t absolutely guaranteed to work.”
Whatever the reasons for the Fed’s passivity, the point I want to make right now is that all the possible actions Professor Bernanke suggested for a time like this, but which Chairman Bernanke has not, in fact, tried, remain available. Joseph Gagnon, a former Fed official now at the Peterson Institute for International Economics, has laid out a specific plan for much more aggressive quantitative easing; the Fed should move ahead with that plan or something like it right away. It should also commit to modestly higher inflation, say, 4 percent over the next five years—or, alternatively, set a target for the dollar value of GDP that would imply a similar rate of inflation. And it should stand ready to do more if this proves insufficient.
Would such aggressive Fed actions work? Not necessarily, but as Bernanke himself used to argue, the point is to try, and keep on trying if the first round proves inadequate.

Government borrows money through the bond markets.
The third is by actually creating money – printing it and creating it by other means such as quantitative easing.
The fourth is by manipulating money – inflation. We have just seen how insidious this is.
Let’s be idealistic for a moment and imagine that Bitcoin and other independent monies become the globally preferred means to make and receive payment. I do not see this as at all likely in the short term. But in the longer term, I do – and the implications are enormous.
In a flash, the ability for a government to fund itself through the manipulation of money disappears. You can’t obfuscate bitcoin supply – inflation is transparent. You can’t ‘quantitatively ease’ bitcoins. Governments – without a very aggressive and potentially impractical bitcoin confiscation scheme – will struggle to use your bitcoins to bail themselves out.

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It was a ‘global financial tsunami’; we were ‘on the brink’ and ‘staring into the abyss’.1 Capitulating stock markets, bankruptcies, bank runs – events came thick and fast and, at first, nobody seemed to know quite what to do.
Then, under immense pressure from the world of finance, governments and central banks reacted dramatically. They created money and credit on a scale unprecedented in human history. Banks were bailed out, interest rates were slashed to levels never seen before and the process of creating money electronically known as quantitative easing was begun.
The result?
The financial system was saved. Central bankers were hailed as heroes. The idea spread that governments and central banks really can operate an economy. Even those who would normally oppose such interventions seemed to think the right thing had been done.
A few dissenters argued that the few were being bailed out at the expense of the many, that enormous problems in the financial system were simply being deferred when they needed to be faced, and that these problems would only come back on a far greater scale.

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In issuing the mortgage (for which they took the deeds of the house as collateral), the lending bank created money, which was then paid to me. The funds didn’t come from investors or from the deposits of others. The money did not previously exist.
Thus modern electronic money – dollars, pounds and euros – is created through lending. Of course, governments create money through such processes as quantitative easing, but, even so, most money is lent into existence. This power to ‘create’ money through lending is what has made the worlds of banking and finance so large, powerful and rich.
Modern money could thus be defined as ‘electronic debt-based fiat currency’.
Research by UK think tank Positive Money shows that since 1989, money creation has been growing by 11.5% per annum. Compounded over time, the entire money stock doubles every six years and three months.

Austrian-School and post-Keynesian economists have contributed a basic insight to the discussion: Once a credit bubble has inflated, the eventual correction (which entails destruction of credit and assets) is of greater magnitude than government’s ability to spend. The cycle must sooner or later play itself out.
There may be a few more arrows in the quiver of economic policy makers: central bankers could try to drive down the value of domestic currencies to stimulate exports; the Fed could also engage in more quantitative easing. But these measures will sooner or later merely undermine currencies (we will return to this point in Chapter 6).
Further, the way the Fed at first employed quantitative easing in 2009 was minimally productive. In effect, QE1 (as it has been called) amounted to adding about a trillion dollars to banks’ balance sheets, with the assumption that banks would then use this money as a basis for making loans.29 The “multiplier effect” (in which banks make loans in amounts many times the size of deposits) should theoretically have resulted in the creation of roughly $9 trillion within the economy.

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However, some argue that limits to government debt (due to snowballing interest payments) need not be a hard constraint — especially for a large nation, like the US, that controls its own currency.16 The United States government is constitutionally empowered to create money, including creating money to pay the interest on its debts. Or, the government could in effect loan the money to itself via its central bank, which would then rebate interest payments back to the Treasury (this is in fact what the Treasury and Fed are doing with Quantitative Easing 2, discussed below).17
The most obvious complication that might arise is this: If at some point general confidence that external US government debt (i.e., money owed to private borrowers or other nations) will be repaid with debt of equal “value” were deeply and widely shaken, potential buyers of that debt might decide to keep their money under the metaphorical mattress (using it to buy factories or oilfields instead), even if doing so posed its own set of problems.

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Documents released by the Fed on December 1, 2010 showed that more than $9 trillion in total had been supplied to Wall Street firms, commercial banks, foreign banks, and corporations, with Citigroup, Morgan Stanley, and Merrill Lynch borrowing sums that cumulatively totaled over $6 trillion. The collateral for these loans was undisclosed but widely thought to be stocks, CDSs, CDOs, and other securities of dubious value.27 In one of its most significant and controversial programs, known as “quantitative easing,” the Fed twice expanded its balance sheet substantially, first by buying mortgage-backed securities from banks, then by purchasing outstanding Federal government debt (bonds and Treasury certificates) to support the Treasury debt market and help keep interest rates down on consumer loans. The Fed essentially created money on the spot for this purpose (though no money was literally “printed”).

By comparison with the 1970s, when it was the coincidence of inflation and unemployment that left economists clueless, now it is very cheap money coexisting with deflationary pressures, raising the spectre of ‘debt deflation’ and of a collapse of a pyramid of accumulated debt by far exceeding in size that of 2008.
How much of a mystery the present phase of the long crisis of contemporary capitalism presents to its would-be management24 is nowhere more visible than in the practice of ‘quantitative easing’, adopted, under different names, by the leading central banks of the capitalist world. Since 2008, central banks have been buying up financial assets of diverse kinds, handing out new cash, produced out of thin air, to private financial firms. In return they receive titles to future income streams from debtors of all sorts, turning private debt into public assets, or better: into assets of public institutions with the privilege unilaterally to determine an economy’s money supply.

…

Right now, the balance sheets of the largest central banks have increased in the past seven years from around eight to more than twenty trillion dollars (see Figure 4.3, p. 127), not yet counting the gigantic asset buying programme started by the European Central Bank in 2014. In the process, central banks, in their dual roles as public authorities and guardians of the health of private financial firms, have become the most important, and indeed effectively the only, players in economic policy, with governments under strict austerity orders and excluded from monetary policymaking. Although quantitative easing has completely failed to counter the deflationary pressures in an economy like Japan – where it has been relied upon for a decade or more on a huge scale – it is steadfastly pursued for lack of alternatives, and nobody knows what would happen if cash-production by debt-purchasing was ended. Meanwhile in Europe, banks sell their no-longer-secure securities, including government papers, to the European Central Bank, either letting the cash they get in return sit with it on deposit, even if they have to pay negative interest on it, or they lend it to cash-strapped governments in countries where central banks are not allowed to finance governments directly, collecting interest from them at a rate above what they could earn in the private credit market.

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Meanwhile in Europe, banks sell their no-longer-secure securities, including government papers, to the European Central Bank, either letting the cash they get in return sit with it on deposit, even if they have to pay negative interest on it, or they lend it to cash-strapped governments in countries where central banks are not allowed to finance governments directly, collecting interest from them at a rate above what they could earn in the private credit market. To this extent, quantitative easing at least serves to rescue, if nothing else, the financial sector.25
Decoupling Democracy
As the crisis sequence took its course, the post-war shotgun marriage between capitalism and democracy came to an end.26 Again this was a slow, gradual development. There was no putsch:27 elections continue to take place, opposition leaders are not sent to prison, and opinions can still by and large be freely expressed in the media, both old and new.

A sell-off of Treasuries by other purchasers would have been predicted, amid a massive run on the dollar. That nothing like this occurred, and that the Treasury’s endorsement of quantitative easing initially elicited little critical comment, was a strong measure of the recognition on the part of global capital—and of the other capitalist states—of the central role of the American state in keeping the system going. The ultimate aim of quantitative easing was to try to get the banks to lend so as to stimulate the economy at a time when, despite continued high unemployment, the balance of Congressional forces was shifting against any further fiscal stimulus.
Quantitative easing essentially involved an audacious printing of US dollars, and thus relied on the willingness of foreign investors and central banks to continue to hold dollars; it served as the strongest reminder to date of the special ongoing attractiveness of the dollar.

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A lower dollar devalued their holdings of US assets, undermined the relative competitiveness of their economies, and—as excess dollars found their way abroad—aggravated inflationary pressures. But given these states’ structural positions within global capitalism, and their economic ambitions, they saw no option but to continue to hold and even increase their dollar holdings. Although there was no little handwringing at home and abroad about the potentially inflationary effects of quantitative easing, inflation was not a problem in the US, especially given the continuing weakness of American labor, and this was reinforced by high unemployment. As for Europe, although quantitative easing did provide additional liquidity for European banks, inflation was also not a serious problem there. This was because European governments had already been forced to move so far in the direction of austerity by the toll financial markets had exacted on the bond sales that many of them needed to cover fiscal deficits following the bailouts of their banks and decline in tax revenue.

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For the lessons the Fed drew for this exercise based on its earlier “stress tests,” see Beverley Hirtle, Til Schuermann, and Kevin Stiroh, “Macroprudential Supervision of Financial Institutions: Lessons from the SCAP,” Federal Reserve of New York Staff Reports, no. 409, November 2009.
88 The aim of quantitative easing was less to control medium- and long-term market rates, although this was how the program was sold to the public, than to stabilize market valuations of securities and sustain interbank markets. Thus, while QE1 in November 2008 involved the purchase of both Treasury bonds and GSE securities ($300 billion and $200 billion respectively), the essence of the project was the socialization of bank losses and risk. The QE2 purchase of Treasury bond securities ($600 billion) two years later had the similar effect of increasing private banks’ reserve holdings, but with bank balance sheets now significantly improved, the Fed was now able to manipulate the interest it paid on the reserves that the banks held with it. See Alan S. Blinder, “Quantitative Easing: Entrance and Exit Strategies,” Federal Reserve Bank of St.

Banks use this reserve to operate and meet the withdrawal needs of their customers, while the Federal Reserve uses this reserve to achieve its own policy goals of either expanding or contracting the money supply. Increasing the reserve requirement (forcing banks to hold on to more money) contracts the money available to lend and decreasing the reserve requirement increases it.
Finally, the Federal Reserve has recently engaged in a controversial strategy called quantitative easing (QE) to get a slow economy moving when the above measures have failed to increase lending. Quantitative easing entails the Fed’s purchase of a large quantity of securities in the open market to pump even more money into the banks—hence “quantitative easing.” Under QE, the Fed purchases U.S. Treasury notes and mortgage-backed securities using newly created electronic cash, which increases bank reserves. In theory, this provides banks with more money to lend so they will lower interest rates and make more loans. In 2008, the Federal Reserve bought over $1.25 trillion in mortgage-backed securities from banks on the theory that the banks would use this money to lend.

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This occurs both directly, through influencing the loan rates charged by banks, but also indirectly through the overall effect of monetary policy on economic activity in the economy.” McLeay, Radia, and Thomas, “Money Creation,” 16.
14. See Peter Conti-Brown, The Structures of the Federal Reserve Independence (Princeton, NJ: Princeton University Press, 2015).
15. See Kimberly Amadeo, “What is Quantitative Easing: How the Federal Reserve Created Massive Amounts of Money,” About News, October 14, 2014, accessed March 13, 2015, useconomy.about.com/od/glossary/g/Quantitative-Easing.htm; “What is Quantitative Easing?,” Economist, January 14, 2014, accessed March 13, 2015, www.economist.com/blogs/economist-explains/2014/01/economist-explains-7.
16. “No one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates.” Bob Ivry, Bradley Keoun, and Phil Kuntz, “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress,” Bloomberg, November 27, 2011, accessed March 13, 2015, www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html.

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Because the central bank controls the supply of currency, the cost of credit circulating through the economy at any given moment is largely a policy decision made by the government’s central bank.
Our central bank in the United States, the Federal Reserve, uses four levers to shape the economy and control monetary supply: (1) the federal fund rate, (2) the discount rate, (3) reserve requirements, and (4) “quantitative easing.” The central bank uses all of these measures, which are only possible with the help of the banking system, to influence the economy.14
The federal fund rate is the rate at which banks lend to each other, which influences the interest rate for all lending. Given the state of the economy and the Fed’s policy goals, it sets a target interest rate that it believes will be optimal. To reach this rate, the Federal Open Market Committee (FOMC) buys or sells government securities from or to banks depending on whether it wants to increase or decrease the economy’s money supply.

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The End of Alchemy: Money, Banking and the Future of the Global Economy
by
Mervyn King

Radical though they sound, neither is in fact different in essence from the policies that have so far failed to generate a return to pre-crisis paths of output. Financing more government spending by printing money is equivalent, in economic terms, to a combination of (a) additional government spending financed by issuing more government debt and (b) the creation of money by the central bank to buy government debt (the process known as quantitative easing). Equally, helicopter drops of money are equivalent to a combination of debt-financed tax cuts and quantitative easing – the only difference being that the size of spending or tax cuts is decided by government and the amount of money created is decided by the central bank. Since both elements of the combination have been tried on a large scale and have run into diminishing returns, it is hard to see how even more of both, producing a short-run boost to demand that will soon peter out, will resolve the paradox of policy.

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The impact of the crisis was to make debtors and creditors – households, companies and governments – uncomfortably aware that their previous spending paths had been based on unrealistic assessments of future long-term incomes. So they reduced spending. And central banks then had to cut interest rates yet again to bring more spending forward from the future to the present, and to create more money by purchasing large quantities of assets from the private sector – the practice known as unconventional monetary policy or quantitative easing (QE). There is in fact nothing unconventional about such a practice – as I will explain in Chapter 5, so-called QE was long regarded as a standard tool of monetary policy – but the scale on which it has been implemented is unprecedented. Even so, it has become more and more difficult to persuade households and businesses to bring spending forward once again from an ever bleaker future. After a point, monetary policy confronts diminishing returns.

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It is ironic, therefore, that economists who believe that money matters (for example, Milton Friedman) argue that ‘the demand for money is highly stable’, whereas Keynesian economists argue that money does not matter because its demand is unstable.27 Both groups are wrong – money really matters when there are large and unpredictable jumps in the demand for it.
The method used to create money was to buy government bonds from the private sector in return for money.28 Those bond purchases were described by many commentators as ‘unconventional’ monetary policies and became known as ‘quantitative easing’, or QE. They were regarded as newfangled and untried. If history is what happened before you were born, then many of the commentators must be extremely young. For open market operations to exchange money for government securities have long been a traditional tool of central banks, and were used regularly in the UK during the 1980s, when they were given the descriptions ‘overfunding’ and ‘underfunding’.29 What was new in the crisis was the sheer scale of the bond purchases – £375 billion by the Bank of England, almost 20 per cent of GDP, and $2.7 trillion by the Federal Reserve, around 15 per cent of GDP.

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Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist
by
Kate Raworth

The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce.50
States could also transform the distributive impact of monetary policy measures used during recessions. In mild recessions, central banks normally seek to boost the money supply by cutting interest rates in order to stimulate commercial bank lending and hence money creation. In deep recessions, however, once interest rates have already been cut very low, central banks attempt to further boost the money supply by buying back government bonds from commercial banks – a practice known as quantitative easing, or QE – in the hope that the banks will then seek to invest the extra money in expanding productive businesses. But as post-financial-crash experience demonstrated, commercial banks used that extra money to rebuild their own balance sheets instead, buying speculative financial assets like commodities and shares. As a result, the price of commodities such as grain and metals rose, along with the price of fixed assets like land and housing, but new investments in productive businesses didn’t.51
What if, instead, central banks tackled such deep recessions by issuing new money directly to every household as windfall cash to be used specifically for paying down debts – an idea that has come to be known as ‘People’s QE’.52 Rather than inflating the price of bonds, which tends to benefit wealthy asset owners, this approach – which resembles a one-off tax rebate for all – would benefit indebted households.

The Fed can get around this limitation with unconventional monetary policy, which is why it has been buying up large amounts of long-term bonds in its policy of “quantitative easing,” hoping to directly lower long-term interest rates.
This is a second-best solution. The effects of buying up large amounts of government bonds and mortgage-backed securities are not well understood or predictable. The process of unwinding this policy as the Fed sells off these assets is also not entirely predictable or without risk. Given the costs of a sustained period of unemployment, the Fed’s policy is certainly worth the risk, but it would be better if conventional monetary policy could be more effective. (Conventional monetary policy would also raise fewer political objections of the sort that have limited the use of quantitative easing).
The obvious way to give monetary policy more power would be to have a higher initial inflation rate.

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And it would have prevented the world from recognizing that the economics profession was wrong, since its estimate of the structural rate of unemployment would otherwise never have been tested.[14]
As the unemployment rate falls in the years ahead we will face similar controversies. Indeed, prominent voices in the profession claim that the unemployment rates we are now seeing are consistent with the structural rate of unemployment in the economy.[15] From this perspective, efforts by the Fed to boost the economy with low interest rates and quantitative easing, or by Congress to use spending and tax cuts to increase demand, are foolhardy, since they will primarily have the effect of raising the inflation rate while having little impact on output and employment.
Their argument is that the downturn represents a fundamental shift in the economy. In their view, the bursting of the housing bubble left a huge pool of workers with capabilities in construction and manufacturing; when the economy recovers we are not likely to see as much employment in these sectors as before, and so millions of former construction and manufacturing workers will be structurally unemployed.[16]
While this is a minority view in the profession, as evidenced in part by the fact that the Fed’s Open Market Committee has overwhelmingly supported expansionary policy, more moderate voices have argued that the NAIRU is considerably higher than it was before the downturn.

Since the collapse of Lehman Brothers in September 2008, the world’s major central banks have been plowing vast quantities of money into the banking system. The U.S. Federal Reserve has made commitments totaling some $29 trillion, lending $7 trillion to banks during the course of one single fraught week. The Bank of England has spent around £325 billion on quantitative easing alone—a figure that could yet rise to £600 billion—while the U.K. government has committed a total of £1.162 trillion to bank rescues. The European Central Bank has made low-interest loans directly to banks worth at least €1.1 trillion. These measures are not addressing the crisis alone. In April 2013, the Bank of Japan embarked on a quantitative easing program worth some $1.3 trillion, designed to end more than a decade of deflation. The social costs of the crisis, too, have been devastating. These are the costs both of the crisis itself and importantly of the policies used by governments and central banks to alleviate its effects on those very institutions that caused it.

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More recently, however, the bankers did not oppose the significant levels of money creation ($13 trillion of debt to rescue bad loans and other obligations) that went into the bailout and the quantitative easing (QE) program. QE began in March 2009, when the U.S. Federal Reserve bought $1,750 billion of government bonds and mortgage-related and agency securities, and the Bank of England purchased £200 billion ($308 billion) of (mostly) government debt. Despite this, and several subsequent episodes of QE, deflation, not inflation, still appears to be the prevailing concern. Technically, quantitative easing consists of temporary bond purchases, but there is a view, increasingly predominant, that these purchases will turn out to be forever.57 This would be helicopter money,58 or what is otherwise known as direct (or overt) monetary financing.59
Monetary theory is at the heart of this idea.

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Gold was worth less than $30 an ounce until the 1930s and less than $40 until 1970. Gold’s price broke the $1,000 an ounce barrier in 2009, reaching a little more than $1,700 by early 2012. To sympathizers of Menger, this rise provides all the evidence necessary for the declining purchasing power of money once it is untethered from gold. Central banks would never have been able to pursue policies like quantitative easing, for example, if the supply of money was fixed to the supply of a reliable commodity, such as gold. Moreover, money would be worth considerably more as a result. To others, who sympathize with Keynes’s famous description of gold as a “barbarous relic,” linking the supply of money to a commodity with a finite supply spells disaster because it stifles the supply of investment that the economy needs.

Here is a typical pro-inflation argument by Dean Baker of the Center for Economic and Policy Research:
If it is politically impossible to increase the deficit, then monetary policy provides a second potential tool for boosting demand. The Federal Reserve Board can go beyond its quantitative easing program to a policy of explicitly targeting a moderate rate of inflation (e.g., 3–4 percent) thereby making the real rate of interest negative. This would also have the benefit of reducing the huge burden of mortgage debt facing tens of millions of homeowners as a result of the collapse of the housing bubble.22
The problem is, in a deflationary environment when banks aren’t lending, how can the Fed create inflation? This is the biggest problem with the inflation solution in a situation of overleveraging and overcapacity. Quantitative easing exchanges a highly liquid asset (base money, reserves) for less liquid assets (e.g., various financial derivatives), but that won’t cause price or wage inflation if the new money doesn’t reach people who will spend it.23 Even if the Fed monetized all debt, public and private, the essential problem would remain.

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We can still envision a new airport, but we can no longer build it. The magic talisman by which the pronouncement “An airport shall be built here” crystallizes into material reality has lost its power. Human hands, minds, and machinery retain all their capacities, yet we can no longer do what we once could do. The only thing that has changed is our perceptions.
We can therefore see the bailouts, quantitative easing, and the other financial measures to save the economy as further exercises in perception management, but on a deeper, less conscious level. Because what is money, anyway? Money is merely a social agreement, a story that assigns meaning and roles. The classical definition of money—a medium of exchange, a store of value, a unit of account—describes what money does, but not what it is. Physically, it is now next to nothing.

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If a bank’s margin reserves are insufficient to meet requirements, it simply borrows the necessary cash from the Fed or the money markets. If there is a system-wide insufficiency of reserves, then the Fed expands the monetary base through open-market operations. That is why M0 growth typically lags behind M1 and M2 by many months—the opposite of what one would expect from the multiplier effect if we lived in a fractional reserve system (see Keen, “The Roving Cavaliers of Credit”). That is also why recent “quantitative easing” by the Fed and other central banks has done little to increase the money supply.
5. This in fact happened many times; during the Great Depression it happened in nearly every country. Holders of currency demanded gold from banks and ultimately central banks, which eventually said no. In the United States in the 1930s it actually became illegal under Roosevelt’s Executive Order 6102 to hold more than a small amount of gold.

Naturally, the dependence of the price structure and of large parts of the economy on a steady flow of money at low interest rates had become so considerable that the next attempt to return to and sustain “normal” rates and a slower pace of money growth initiated another downturn and now even kicked off a severe financial crisis. This was the so-called subprime crisis that commenced in the summer of 2007.
Not surprisingly, the U.S. Federal Reserve did go again one step further, now adopting practically zero policy rates and conducting aggressive debt monetization, labeled “quantitative easing,” a policy in which it was followed by the Bank of England. But again, Japan had preceded everybody by a few years, having conducted zero-rate policies and quantitative easing from 2001 to 2006. When Japan had done so, the policy had again been unprecedented and appeared extreme to financial market commentators. The policy establishment began to follow Japanese developments with increasing trepidation, frustration, and even anger. After all, the Japanese used the twentieth century’s newfound policy equipment of money printing and deficit spending, the all-purpose policy tools that allegedly promised an end to any recession.

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Nevertheless, statistics may give us an indication: Industrial production in the United States is about 12 times larger today than it was at the beginning of the Great Depression.2 However, the amount of currency in circulation (notes and coins) is more than 200 times larger today (end of 2010).3 The stock of money in the statistical definition of M1 is about 65 times larger and in the M2 definition about 150 times larger.4 By the end of 2010, the Federal Reserve was on its second round of quantitative easing, which meant that the monetary base and bank reserves were more than 330 times larger than in October 1929.5 Total net debt as a percent of GDP—which stood at about 150 percent when Nixon took the dollar off gold—reached a record high of 370 percent in the third quarter of 2009. At the time of the 1929 stock market crash, this ratio stood at less than 200 percent and was thus half of what it is today.6
It is part of the inherent logic of the present system that policy makers must do everything to avoid a rise in interest rates, as such a rise would reveal the true availability of savings, which naturally is much more limited than what artificially lowered interest rates have consistently projected.

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The ECB felt compelled to buy Greek, Portuguese, and Irish government bonds in particular as investors sold these securities heavily out of fear of sovereign insolvency. The reason for the central bank’s intervention was to avoid a spreading of the sovereign debt crisis to other and bigger members of the monetary union, none of which are fiscally sound. In the United States, where the government is running record budget deficits, the central bank has, with its second round of so-called quantitative easing, become the biggest marginal buyer of U.S. government bonds and will soon be the largest holder.
The central bankers make every effort to portray these market interventions as only temporary. They are supposed to appear as creative stimulus measures or as short-term maneuvers that guarantee stability and liquidity. In fact, our analysis has shown that these policies are the inevitable next steps in the deterioration of the paper money system and that we should expect them to be continued and indeed expanded.

What we did with money in the run-up to 2008 was to massively expand its volume: the global money supply rose from $25 trillion to $70 trillion in the seven years before the crash – incomparably faster than growth in the real economy. When money expands at this rate, it is a sign that we think the future is going to be spectacularly richer than the present. The crisis was simply a feedback signal from the future: we were wrong.
All the global elite could do once the crisis exploded was put more chips on the roulette table. Finding them, to the tune of $12 trillion in quantitative easing, was no problem since they themselves were the cashiers at the casino. But they had to spread their bets more evenly for a while, and become less reckless.12
That, effectively, is what the policy of the world has been since 2008. You print so much money that the cost of borrowing it for banks becomes zero, or even negative. When real interest rates turn negative, savers – who can only keep their money safe by buying government bonds – are effectively forced to forgo any income from their savings.

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It was Treasury Secretary Larry Summers who, in 1999, through the repeal of Glass-Steagall, opened the banking system to the attentions of those adept at exotic, opaque and offshore forms of finance.
Fiat money, then, contributed to the crisis by creating wave after wave of false signals from the future: the Fed will always save us, shares are not risky and banks can make high profits out of low-risk business.
Nothing demonstrates the continuity between pre- and post-crisis policy better than quantitative easing (QE). In 2009, having wavered before the enormity of the task, Bernanke – together with his UK counterpart Mervyn King, governor of the Bank of England – started the presses rolling. In November 2008 China had already begun printing money in the more direct form of ‘soft’ bank loans from the state-owned banks to businesses (i.e. loans that nobody expected to be repaid). Now the Fed would print $4 trillion over the next four years – buying up the stressed debts of state-backed mortgage lenders, then government bonds, then mortgage debt, to the tune of $80 billion a month.

…

Interest rates35
Kondratieff measured his waves using interest rates, and for the post-1945 period there is no clearer metric than this one: the average interest rates banks charge to companies and individuals in the USA. Interest rates rose gradually during the long boom, spiked in the early 1980s – when high interest rates were used to wipe out swathes of the old industries – and have gradually declined, flatlining at the end of the graph because of quantitative easing. Kondratieff’s colleagues, who’d seen this exact pattern in all the previous cycles, would have concluded: ‘Comrade, that’s a long wave.’
3. Commodity prices: nickel
However, Kondratieff also tracked the prices of basic commodities, such as coal and iron. This graph tracks the price of a modern equivalent, nickel – a key component of stainless steel – over fifty-seven years. I think it would have knocked Kondratieff off his chair.

In 2009 and 2010, through fees and interest, TALF generated $721 million in profits for the Fed, which didn’t pay out a dime in guarantees.4
These efforts were short-term emergency interventions to unclog the nation’s—and the world’s—financial plumbing. Other interventions were made to keep interest rates low and to jolt the economy back into life. After the financial panic passed, the Federal Reserve continued to add new assets to its balance sheet, creating new money to buy $1 trillion in mortgage-backed securities in 2009, in the first round of what came to be known as “quantitative easing” (QE). In late 2010 and early 2011, in a second round of quantitative easing, the Fed bought $600 billion in Treasury securities. But the overall balance sheet didn’t expand by anywhere near $1.6 trillion as a result of QE1 and QE2, thanks to the slow-motion erosion of crisis-era facilities and loans. Each week, as people made payments on mortgages and refinanced and sold homes, the mortgage-backed securities portfolio shrank.

…

Having spent a week getting acquainted with the depopulating, self-doubting country, I gulped hard. But Nishimura’s takeaway was an optimistic one. In the 1990s Japanese policymakers deliberated and delayed before embarking on a regime of interest rate cuts, stimulus measures, an expansion of bank deposit insurance, a partial nationalization of failed institutions, bank capital injections, a zero-interest-rate policy, quantitative easing, and still more stimulus. The United States, he said, had essentially undertaken the same response, with one significant difference: speed. It took the United States just eighteen months to conduct the aggressive fiscal and monetary actions that Japan waited twelve years to carry out. Whereas Japan’s first major stimulus came seven quarters after its commercial real estate bubble peaked, the U.S. policymaking apparatus responded to the downturn much more quickly.

…

In 2010 and 2011 the consumer was more like a weightlifter who has strengthened his legs and core and has learned how to use them. As a result the vicious debt circle of 2008 and 2009 was increasingly replaced by a virtuous circle in 2010 and 2011. Higher demand—led by global growth, rising government expenditures, and a recovering private sector—spurred job creation starting in February 2010. And this process gained steam even as the effects of policy and public spending withered. The Federal Reserve’s quantitative easing helped keep interest rates low in 2010 and 2011, but petered out in the second half of 2011. The stimulus and government assistance, so vital to averting a Great Depression in 2008 and 2009, began to wane in 2010. Meanwhile states and cities were acting as brakes on growth by cutting spending and employment. In what’s been dubbed “the conservative recovery,” the private sector persistently added jobs even as the public sector just as persistently cut them.

The mood of foreboding grew darker still on May 6th 2010, the day of a strange “flash-crash” on Wall Street, in which the Dow Jones Industrial Average collapsed by about 1,000 points before recovering within minutes, perhaps because of a technical glitch. The ECB’s governing council, in Lisbon that day for its monthly meeting, faced a momentous decision: should it start buying sovereign bonds to stop the panic? The Federal Reserve and the Bank of England had been doing so under their policy of quantitative easing to bring down long-term borrowing costs. But the ECB had not gone so far, wary of the prohibition against anything resembling “monetary financing”, that is, printing money to finance public debt. After the official meeting, Trichet told journalists that the subject of bond-buying had not been discussed. Later on over an informal dinner, however, the council had reached a tentative agreement to start selectively buying the bonds of vulnerable countries.4 The next day, as leaders gathered in Brussels for a euro-zone-only summit, ostensibly to endorse the bail-out of Greece, many participants seemed unaware that they would be called upon to do something much bigger: set up a safety net for the whole euro zone.

…

The ECB had its own twin fears, both of them German. They were called “Bundesbank” and “Karlsruhe”. The inflation-busting tradition of the Bundesbank meant that the ECB would rather flirt with deflation than let prices rise too high in Germany, or upset German savers by more aggressive lowering of interest rates. It never dared engage in the aggressive loosening of monetary policy, known as “quantitative easing” (involving the purchase of government bonds and other assets), long pursued by the US Federal Reserve and the Bank of England. Excessively low inflation, overly tight monetary policy and a high exchange rate made it even harder for the periphery to adjust relative to Germany. The Bundesbank openly opposed any resort to bond-buying to hold down borrowing costs. And the ECB soon ran up against the even greater intransigence of the German constitutional court, which ruled that Draghi’s policy of outright monetary transactions (OMT), the one true firewall that had arrested the financial blaze, was illegal (though it offered a stay of execution by passing the case on to the European Court of Justice).

…

And given that its supervisory role already raises questions about its political independence, not least because bank failures have an impact on national treasuries, the ECB should get out of the entanglement of the troika.
For now, the ECB must have the courage to loosen monetary policy more aggressively, despite German complaints that savings are being undermined, to avert the threat of deflation. A dose of American-style quantitative easing may be in order. Once again, though, it would be easier if the ECB had Eurobonds to buy instead of having to pick and choose which country’s debt to buy and which to exclude.
Narrow the democratic deficit
The integration of the euro zone, the intrusion of European bodies into national economic policymaking and the growing popular disenchantment with the European project require the democratic deficit to be addressed more urgently than ever.

Analysis of official data by the Centre for Research on Socio-Cultural Change at Manchester University for the Guardian; Aditya Chakrabortty, ‘London's economic boom leaves rest of Britain behind’, Guardian, 23 October 2013, at: www.theguardian.com/business/2013/oct/23/london-south-east-economic-boom
23. Claire Jones and Chris Giles, ‘King warns over surge in asset prices’, Financial Times, 13 February 2013, at: www.ft.com/cms/s/0/756c4840–75ff–11e2–9891–00144feabdc0.html#axzz2jt3EgRGf For a fuller explanation and analysis of quantitative easing, see M. Joyce, M. Tong and R. Woods, ‘The United Kingdom's quantitative easing policy: Design, operation and impact’, Bank of England Quarterly Bulletin, 51:3 (2011), pp. 200–12.
24. For a comparison of Chamberlain's and Osborne's rhetoric, see Duncan Weldon, 'UK recession: Have we heard it all before?’, Guardian, 25 July 2013, at: www.guardian.co.uk/commentisfree/2012/jul/25/uk-recession-george-osborne-neville-chamberlain
25.

…

But a few years on, and to the extent that variable recoveries allow it, both Britain and the US are heading back towards business as usual. The basic model has not been reformed. In the UK, new analysis of official data shows that the proportion of bank lending going to productive businesses is actually lower than it was before the bust.22 Meanwhile, orthodox voices such as Sir Mervyn King, former Bank of England governor, openly worry that a recovery pumped by so-called quantitative easing – the policy of printing money to pour into financial assets – could even inflate a fresh bubble.23 If that is right, another bust could become conceivable sooner than anyone would like to imagine. But even if the recovery is sustained, it is built on the same old foundations. Both British and American societies will live with the consequences, as the effects of the Great Recession – which might soon be forgotten in more prosperous neighbourhoods – dog poor communities into the indefinite future.

…

Just as with taxes and spending, macroeconomic choices over interest rates and so on will create winners and losers, and the balance of political power between them will bear upon the direction of policy.5 But monetary policy in the Great Recession has been nothing like as controversial as during the Depression: this time reflationists have carried the day with relative ease in Britain and America, if not continental Europe. Although it is worth noting in passing that ‘quantitative easing’ has disproportionately boosted the value of assets held by the rich,6 even this unprecedented aspect of the monetary stance has not proven especially divisive. It thus makes sense for us to concentrate on the fiscal side, and most especially social expenditure and redistribution.
In tracing public opinion on these things, we will concern ourselves not with particular policies or plans (which inevitably evolve over time, and on which many voters will typically have no view), but rather with support for the broad underlying principles of providing for the poor and pooling risk – principles as pertinent today as they were in the hard times of the 1930s.

There are some inflationary pressures not even the most vigorous action by the Federal Reserve can just wipe out‌—‌China’s rapid growth and consequent demand for raw materials, for example. You can’t expect Ben Bernanke, chairman of the Fed, to be able to do anything about that. On the other hand, the Fed’s response to the rapidly declining value of the dollar has been to assist that decline in every way possible. I pointed out in chapter 1 that the Fed has allowed its balance sheet to inflate by some $2,000 billion, largely as a result of quantitative easing (to use the technical term) or printing money (to use the descriptive one). This ‘easing’ has taken place at a time when the Fed has already forced down short-term interest rates as low as they can possibly go, lower than they’ve been for generations.9 It has come at a time when long-term interest rates are as low as they’ve been since Japanese bombs were falling on Pearl Harbor.10 In addition, it’s come at a time when the threat of deflation (an admittedly serious possibility) has long, long retreated.

…

I was more certain of some of the potential costs.
One cost is the risk of being perceived as embarking on the slippery slope of debt monetization [i.e. printing money to support government borrowing]. We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises.
I realized that two other central banks were engaging in quantitative easing—the Bank of Japan and, most notably, our friends at the Bank of England. But the Bank of England is offsetting an announced fiscal policy tightening that out-Thatchers Thatcher. This is not the case here. Here we suffer from fiscal incontinence and regulatory misfeasance. If this were to change, I might advocate for accommodation. But that is not yet happening. And I worry that by providing monetary accommodation, we are reducing the odds that fiscal discipline will be brought to bear.11
Fisher puts his finger on precisely the right issue.

…

Cotton prices are also exceptionally volatile.29 The same has been true of cocoa futures.30 By good fortune, none of these flash crashes have yet caused much damage, but poorly maintained levees didn’t do much harm to New Orleans until 2005. The mortgage market looked to be working fine, until it came close to destroying the international financial system.
In 2010 we were fortunate that the flash crash happened when the markets were still being buoyed up by ultra-low interest rates, by quantitative easing, by massive fiscal stimulus, and by a broad sense of returning security in the financial markets. Those props (disastrous as they’re proving in the longer run) were enough to stop the meltdown. But just suppose the next crash happens when another major financial institution is on the brink. When nerves are shredded. When panic is only half a rumor away. Under these circumstances, a flash crash could easily precipitate failure on a Lehman-like scale.

At the same time, the lack of demand for credit causes
creditors to also reduce their expenditures. The cumulative effect of these two changes
results in choking investments, higher unemployment levels, and a reduced demand for
goods and services. In the past, to overcome these effects and boost spending, monetary
policies aimed at reducing interest rates and employed the use of nontraditional
instruments, such as quantitative easing (QE), in order to boost the supply of credit.
While the effects of QE and other recently employed tools will be discussed in a later part
of this book, the key point to consider is that the use of such measures is limited, since
borrowers who are already overleveraged do not wish to get into more debt. Hence, the
demand side of credit availability becomes the more pressing issue (Koo, 2014), for even
if credit is supplied at a low price, the debt overhang effect reduces the demand for credit.

…

The enactment of the Volker rule, which restricts US banks from making certain kinds of
speculative investments that do not benefit their customers, is a return to the older form
of banking regulations when deposits were not used to trade on the bank’s own accounts.
While the net effect of these rulings, along with stricter regulations following
the LIBOR23 scandal, do apply new restrictions on the ability of commercial banks to
participate in speculative activities, they have been coupled with extraordinary measures
such as quantitative easing (QE) and quantitative and qualitative easing24 (QQE). This
is not to say that the regulators and central bankers were wrong in doing what they did.
Following the events of the crisis of 2008, pumping money into the economy at ultra-low
rates was better than not taking any action. But it replays the dance with debt all over
again, as thanks to the current modus operandi, governments have to borrow and pay
interest to central banks for the newly minted money they push into the economy.

…

LIBOR is used to settle contracts on
money market derivatives and is also used as a benchmark to set payments on about $800 trillion
worth of financial instruments, ranging from complex interest-rate derivatives to simple mortgages.
Source: The Economist: http://www.economist.com/node/21558281
24
Qualitative easing means targeting certain assets to try to drive up their prices and drive down
their yields, whereas quantitative easing is unspecific and intends to drive down interest rates
across the whole spectrum of assets. Source: Bloomberg: http://www.bloomberg.com/news/
articles/2014-10-31/what-the-heck-is-japans-qqe2
23
23
Chapter 1 ■ Debt-based Economy: The Intricate Dance of Money and Debt
banking. While a number of measures have been taken to address some of these issues,
these measures have been reactive rather than proactive.

Issue Bonds and Print Money
First, EU (rather than exclusively national) bonds can be created. These will effectively give Europe a ﬁscal capacity that is,
for all intents and purposes, equivalent to that of the U.S.
Treasury. Second, given the deﬂation problem, the European
Central Bank can now follow the Bank of England and the
Swiss National Bank by entering the next tier of quantitative
easing, expanding its balance sheet and starting to buy those
crisp new EU bonds in the primary market.
(Quantitative easing, which is simply a generic way of referring to all the recent attempts to boost money supply when
interest rates fall close to zero, becomes in this particular case
a euphemism for “printing money,” with the unusual characteristic that this time, inﬂation is exactly what we are looking
for. And if we don’t get it, well, as Paul Krugman wrote in a
97
The Global Financial Crisis
Eastern Europe Is Going Backward
The view in the East is that the onset of the world economic crisis has suddenly reversed globalization.

We then statistically relate for each year, over the past
60 years, the market values (the product of stock price and the number
of shares outstanding) of all US public companies with the required data
to their recent respective earnings and book value (see the Appendix for
a more formal discussion of this analysis). Market values (capitalization)
of companies reflect, of course, multiple sources of information, such as
interest rates, industry conditions (e.g., depressed real estate in the financial
crisis), and monetary policy (the Fed’s “quantitative easing”), in addition to
The Widening Chasm between Financial Information and Stock Prices
33
companies’ earnings and book values. Accordingly, our statistical methodology (a regression analysis) enables us to answer the following question:
Of all the information items reflected in companies’ market values (stock
prices), how much is attributed to corporate earnings and book values? This
is the message of Figure 3.1: roughly 80 to 90 percent in the 1950s and 1960s
versus 50 percent today.

…

Pretty
good for a back-of-the-envelope forecast, even compared with the 17
54
MATTER OF FACT
financial analysts following Exxon—all experts on Exxon and the oil and
gas industry—which had in January 2012 a mean (consensus) full-year
earnings estimate of $46.27 billion, overshooting actual earnings by 3.1
percent. Surprise—you are in the same league as the experts.
One can devise, of course, more sophisticated models to predict earnings
than the above: last-year’s earnings plus average growth. Taking into account
expected events—like the termination of the Fed’s “quantitative easing,”
leading to higher interest rates, or an impending corporate acquisition—will
likely improve the accuracy of the forecast. But our aim in this chapter is
not to devise the best earnings prediction model, but rather, to focus on the
ability or usefulness of reported earnings to predict those in the future. Our
test is designed for this specific purpose.7
Back to our task of assessing reported earnings’ usefulness over time.

…

Even a far larger disaster, British Petroleum’s (BP) 2010 oil spill in the Gulf of
Mexico, costing the company tens of billions of dollars, didn’t dethrone BP from
its membership in the group of major international oil companies. The current
(2016) oil glut and price drops may prove more consequential to oil companies.
7. As an aside, any prediction model that incorporates other predictions (like the
expected rising interest rates post quantitative easing) is subject to additional
inaccuracies from the errors of those predictions. So our prediction, based solely
on adjusted reported earnings, may perform quite well compared with “more
sophisticated” ones. See, for example, Joseph Gerakos and Robert Gramacy,
Regression-Based Earnings Forecasts, working paper (Chicago: University of
Chicago, 2013).
8. An alternative, often used by researchers, is to compute the “root mean-squared
error,” which is computed by squaring the errors, averaging them, and taking
the square root of the average, which also abstracts from the error sign.
9.

No one thanks the person who exposes the bezzle.
Traditional monetary policy involved setting interest rates and supplying or reducing liquidity in the banking system through ‘open market operations’ – trading in the government’s own debt. The more recent policy, known as ‘quantitative easing’, involves the central bank buying assets from the financial sector – not just banks, and not necessarily only government securities. Though this policy enjoyed little success in stimulating the Japanese economy when it was first tried there in the 1990s, quantitative easing has been extensively adopted since 2009 by the Federal Reserve Board and the Bank of England. The balance sheet of the Federal Reserve System totalled just under $900 billion in 2007: by 2014 this figure had risen fivefold to almost $4.5 trillion.7 The Bank of England’s balance sheet has been multiplied by ten, from £39 billion to £399 billion.8 While British government debt of around £1.4 trillion is the highest it has ever been, the Bank of England itself is by far the largest holder of this debt.

…

But such information asymmetry is a benefit rather than a problem: if the British government knows it is not going to default on debt when the bond market believes otherwise, a state that can issue as much short-term debt (money) as it likes can use the misapprehension to refinance its debt on favourable terms, buying back its own long-term debt for subsequent reissue.
The policy has been followed during quantitative easing, but at the wrong time, for the wrong reasons and with the wrong consequences. Far from being abnormally high in anticipation of a possible default, long-term interest rates in developed economies are at historically unprecedented lows. The governments of Britain, France, Germany and the USA can today borrow for decades ahead at low or even negative real interest rates. But instead of issuing such debt, Britain and the USA have been buying it back in exceptional quantities in order to sustain asset prices and help recapitalise the banking system.

Calculated as the discount rate that makes the net present value of all
future cash flows zero
Investment banking: providing specialist investment banking services,
including capital markets activities and M&A advice, to large clients
(corporations and institutional investors)
Glossary
xi
Investment banking adviser: see Adviser
Islamic banking: banking structured to comply with Shariah (Islamic) law
Junior debt: debt that is subordinated or has a lower priority than other
debt
Junk bond: see High yield bond
Lenders: providers of debt finance
Leverage: debt
Leveraged acquisition: acquisition of a company using high levels of debt
to finance the acquisition
LIBOR: London Inter-Bank Offered Rate, the rate at which banks borrow
from other banks
Liquidity: capital required to enable trading in capital markets
M&A: mergers and acquisitions; typically the major advisory department
in an investment bank
Market abuse: activities that undermine efficient markets and are proscribed under legislation
Market capitalism: a system of free trade in which prices are set by supply
and demand (and not by the Government)
Market maker: a market participant who offers prices at which it will buy
and sell securities
Mis-selling: inaccurately describing securities (or other products) that are
being sold
Moral hazard: the risk that an action will result in another party behaving
recklessly
Moral relativism: the concept that morals and ethics are not absolute, and
can vary between individuals
Multi-notch downgrade: a significant downgrade in rating or recommendation (by a rating agency)
Natural law: the concept that there is a universal moral code
Net assets: calculated as total assets minus total liabilities
Net present value (NPV): sum of a series of cash inflows and outflows
discounted by the return that could have been earned on them had they
been invested today
NYSE: New York Stock Exchange
Operating profit: calculated as revenue from operations minus costs from
operations
P:E: ratio used to value a company where P (Price) is share price and E
(Earnings) is earnings per share
Price tension: an increase in sales price of an asset, securities or a business
resulting from a competitive situation in an auction
xii Glossary
Principal: equity investor in a transaction
Principal investment: proprietary investment
Private equity: equity investment in a private company
Private equity fund: investment funds that invest in private companies
Proprietary investment: an investment bank’s investment of its own
capital in a transaction or in securities
Qualifying instruments: securities covered by legislation
Qualifying markets: capital markets covered by legislation
Quantitative easing: Government putting money into the banking system
to increase reserves
Regulation: legal governance framework imposed by legislation
Restructuring: investment banking advice on the financial restructuring
of a company unable to meet its (financial) liabilities
Returns: profits
Rights-based ethics: ethical values based on the rights of an individual, or
an organisation
SEC: the Securities and Exchange Commission, a US regulatory authority
Sarbanes–Oxley: the US “Company Accounting Reform and Investor
Protection Act”
Senior debt: debt that takes priority over all other debt and that must be
paid back first in the event of a bankruptcy
Shariah finance: financing structured in accordance with Shariah or
Islamic law
Sovereign debt: debt issued by a Government
Speculation: investment that resembles gambling; alternatively, very
short-term investment without seeking to gain management control
Socially responsible investing (SRI): an approach to investment that aims
to reflect and/or promote ethical principles
Spread: the difference between the purchase (bid) and selling (offer) price
of a security
Subordinated debt: see Junior debt
Syndicate: group of banks or investment banks participating in a securities
issue
Syndication: the process of a group of banks or investment banks selling
a securities issue
Takeover Panel: UK authority overseeing acquisitions of UK public companies
Too big to fail: the concept that some companies or sectors are too large
for the Government to allow them to become insolvent
Glossary
xiii
Unauthorised trading: trading on behalf of an investment bank or other
investor without proper authorisation
Universal bank: an integrated bank
Utilitarian: ethical values based on the end result of actions, also referred
to as consequentialist
Volcker Rule: part of the Dodd–Frank Act, restricting the proprietary
investment activities of deposit-taking institutions
Write-off: reduction in the value of an investment or loan
Zakat: charitable giving, one of the five pillars of Islam
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1
Introduction: Learning from Failure
There has been significant criticism of the ethics of the investment banking
sector following the financial crisis.

…

At times during the financial crisis, even reducing interest rates to zero
or near zero did not reduce the cost of borrowing in the way intended.
LIBOR – the cost of money being loaned between banks – in normal market conditions trades closely in line with central bank base rates. During the
financial crisis this gap widened dramatically, for example to 4–5 percentage points above base rates. LIBOR only reduced as Governments actively
intervened to reduce rates through measures such as Quantitative Easing
(QE). This involves a Government putting money into the banking system
to increase reserves by buying financial instruments, typically Government
bonds.
Governments have historically been in a position, when they wish,
for example as an implied result of a democratic mandate, to determine
how industrial and commercial sectors should operate. For a Government
to find that in order to govern it is reliant on the financial stability of
an unstable sector is politically problematic.

There was the $150 billion Term Auction Facility (TAF); $50 billion in swap lines for foreign central banks; the $200 billion Term Securities Lending Facility (TSLF); the $20 billion Primary Dealer Credit Facility (PDCF); the $700 billion Commercial Paper Funding Facility (CPFF); and the $1 trillion Term Asset-Backed Securities Loan Facility (TALF).11 The largest and longest-lasting program introduced by the Fed was the Large-Scale Asset Purchase (LSAP) program. Also known as “quantitative easing,” it involves the Fed buying long-term assets that include agency debt, mortgage-backed securities, and long-term treasuries from banks. It has been enormous by any standard. By the middle of 2013, these Fed purchases had increased the size of its balance sheet from around $800 billion in 2007 to a whopping $3.3 trillion.
The financial crisis in the fall of 2008 had an added complication because banks were funding themselves with very short-term financing instruments that weren’t deposits.

…

Once again, the natural forces of the economy move against inflation and toward deflation during a severe economic downturn. Monetary policy fights an uphill battle.
Are central banks willing to act irresponsibly enough to win? The evidence suggests no. The European Central Bank has been conservative in its approach, as has the Bank of England. The Federal Reserve has pushed the envelope with aggressive quantitative easing and conditional guidance language in its statements. But as former chair of the Council of Economic Advisers Christina Romer put it, “The truth is that even these moves were pretty small steps . . . the key fact remains that the Fed has been unwilling to do a regime shift. And because of that, monetary policy has not been able to play a decisive role in generating recovery.”14
Relying on monetary policy to generate inflation through expectations may work beautifully in macroeconomic models.

In the same period, the U.S. share of world GDP has remained, and is forecast to remain, fairly steady at around 26 percent.
At the same time, Europe has become accustomed to a high level of structural unemployment. Indeed, if we exclude the United Kingdom, the EU failed to produce a single net private-sector job between 1980 and 1992. Only now, as the U.S. applies a European-style economic strategy based on fiscal stimulus, nationalization, bailouts, quantitative easing, and the regulation of private-sector remuneration, has the rate of unemployment in the U.S. leaped to European levels.
For the past 40 years, Europeans have fallen further and further behind Americans in their standard of living.
Some EU leaders privately recognize that the U.S. economy is more dynamic than their own, and they occasionally issue staccato statements to the effect that they really ought to do something about it.

A catalogue record for this book is available from the British Library
Library of Congress Cataloging in Publication Data available
eISBN 9781780322209
CONTENTS
Tables, figures and boxes
Preface to the second edition
Preface to the first edition
1 Predicting the ‘unpredictable’
2 No more Mr Nice Guy
Part 1 Foundations: the logical flaws in the key concepts of conventional economics
3 The calculus of hedonism
4 Size does matter
5 The price of everything and the value of nothing
6 To each according to his contribution
Part 2 Complexities: issues omitted from standard courses that should be part of an education in economics
7 The holy war over capital
8 There is madness in their method
9 Let’s do the Time Warp again
10 Why they didn’t see it coming
11 The price is not right
12 Misunderstanding the Great Depression and the Great Recession
Part 3 Alternatives: different ways to think about economics
13 Why I did see ‘It’ coming
14 A monetary model of capitalism
15 Why stock markets crash
16 Don’t shoot me, I’m only the piano
17 Nothing to lose but their minds
18 There are alternatives
Bibliography
Index
TABLES, FIGURES AND BOXES
Tables
2.1 Anticipations of the housing crisis and recession
3.1 ‘Utils’ and change in utils from consuming bananas
3.2 Utils arising from the consumption of two commodities
3.3 The commodities in Sippel’s ‘Revealed Preference’ experiment
4.1 Demand schedule for a hypothetical monopoly
4.2 Costs for a hypothetical monopoly
4.3 Sales and costs determine the level of output that maximizes profit
4.4 Cost and revenue for a ‘perfectly competitive’ industry identical in scale to hypothetical monopoly
5.1 Input and output data for a hypothetical firm
5.2 Cost drawings for the survey by Eiteman and Guthrie
5.3 Empirical research on the nature of cost curves
7.1 Sraffa’s hypothetical subsistence economy
7.2 Production with a surplus
7.3 Relationship between maximum and actual rate of profit and the wage share of surplus
7.4 The impact of the rate of profit on the measurement of capital
10.1 Anderson’s ranking of sciences
12.1 The alleged Money Multiplier process
13.1 A hypothetical example of the impact of decelerating debt on aggregate demand
13.2 The actual impact of decelerating debt on aggregate demand
14.1 A pure credit economy with paper money
14.2 The dynamics of a pure credit economy with no growth
14.3 Net incomes
14.4 A growing pure credit economy with electronic money
15.1 Von Neumann’s procedure for working out a numerical value for utility
15.2 The Allais ‘Paradox’
15.3 The Allais ‘Paradox’ Part 2
16.1 The solvability of mathematical models
17.1 Marx’s unadjusted value creation table, with the rate of profit dependent upon the variable-to-constant ratio in each sector
17.2 Marx’s profit distribution table, with the rate of profit now uniform across sectors
17.3 Steedman’s hypothetical economy
17.4 Steedman’s physical table in Marx’s value terms
17.5 Steedman’s prices table in Marx’s terms
17.6 Profit rate and prices calculated directly from output/wage data
17.7 Marx’s example where the use-value of machinery exceeds its depreciation
Figures
2.1 US inflation and unemployment from 1955
2.2 Bernanke doubles base money in five months
2.3 Private debt peaked at 1.7 times the 1930 level in 2009
3.1 Rising total utils and falling marginal utils from consuming one commodity
3.2 Total utils from the consumption of two commodities;
3.3 Total ‘utils’ represented as a ‘utility hill’
3.4 The contours of the ‘utility hill’
3.5 Indifference curves: the contours of the ‘utility hill’ shown in two dimensions
3.6 A rational consumer’s indifference map
3.7 Indifference curves, the budget constraint, and consumption
3.8 Deriving the demand curve
3.9 Upward-sloping demand curve
3.10 Separating out the substitution effect from the income effect
3.11 Engel curves show how spending patterns change with increases in income
3.12 A valid market demand curve
3.13 Straight-line Engel ‘curves’
3.14 Economic theory cannot rule out the possibility that a market demand curve may have a shape like this, rather than a smooth, downward-sloping curve
4.1 Leijonhufvud’s ‘Totems’ of the Econ tribe
4.2 Stigler’s proof that the horizontal firm demand curve is a fallacy
4.3 Profit maximization for a monopolist: marginal cost equals marginal revenue, while price exceeds marginal cost
4.4 Profit maximization for a perfectly competitive firm: marginal cost equals marginal revenue, which also equals price
4.5 A supply curve can be derived for a competitive firm, but not for a monopoly
4.6 A competitive industry produces a higher output at a lower cost than a monopoly
4.7 The standard ‘supply and demand’ explanation for price determination is valid only in perfect competition
4.8 Double the size, double the costs, but four times the output
4.9 Predictions of the models and results at the market level
4.10 Output behavior of three randomly selected firms
4.11 Profit outcomes for three randomly selected firms
4.12 Output levels for between 1- and 100-firm industries
5.1 Product per additional worker falls as the number of workers hired rises
5.2 Swap the axes to graph labor input against quantity
5.3 Multiply labor input by the wage to convert Y-axis into monetary terms, and add the sales revenue
5.4 Maximum profit occurs where the gap between total cost and total revenue is at a maximum
5.5 Deriving marginal cost from total cost
5.6 The whole caboodle: average and marginal costs, and marginal revenue
5.7 The upward-sloping supply curve is derived by aggregating the marginal cost curves of numerous competitive firms
5.8 Economic theory doesn’t work if Sraffa is right
5.9 Multiple demand curves with a broad definition of an industry
5.10 A farmer who behaved as economists advise would forgo the output shown in the gap between the two curves
5.11 Capacity utilization over time in the USA
5.12 Capacity utilization and employment move together
5.13 Costs determine price and demand determines quantity
5.14 A graphical representation of Sraffa’s (1926) preferred model of the normal firm
5.15 The economic theory of income distribution argues that the wage equals the marginal product of labor
5.16 Economics has no explanation of wage determination or anything else with constant returns
5.17 Varian’s drawing of cost curves in his ‘advanced’ microeconomics textbook
6.1 The demand for labor curve is the marginal revenue product of labor
6.2 The individual’s income–leisure trade-off determines how many hours of labor he supplies
6.3 An upward-sloping individual labor supply curve
6.4 Supply and demand determine the equilibrium wage in the labor market
6.5 Minimum wage laws cause unemployment
6.6 Demand management policies can’t shift the supply of or demand for labor
6.7 Indifference curves that result in less work as the wage rises
6.8 Labor supply falls as the wage rises
6.9 An individual labor supply curve derived from extreme and midrange wage levels
6.10 An unstable labor market stabilized by minimum wage legislation
6.11 Interdependence of labor supply and demand via the income distributional effects of wage changes
7.1 The standard economic ‘circular flow’ diagram
7.2 The rate of profit equals the marginal product of capital
7.3 Supply and demand determine the rate of profit
7.4 The wage/profit frontier measured using the standard commodity
9.1 Standard neoclassical comparative statics
9.2 The time path of one variable in the Lorenz model
9.3 Structure behind the chaos
9.4 Sensitive dependence on initial conditions
9.5 Unstable equilibria
9.6 Cycles in employment and income shares
9.7 A closed loop in employment and wages share of output
9.8 Phillips’s functional flow block diagram model of the economy
9.9 The component of Phillips’s Figure 12 including the role of expectations in price setting
9.10 Phillips’s hand drawing of the output–price-change relationship
9.11 A modern flow-chart simulation program generating cycles, not equilibrium
9.12 Phillips’s empirically derived unemployment–money-wage-change relation
10.1 Hicks’s model of Keynes
10.2 Derivation of the downward-sloping IS curve
10.3 Derivation of the upward-sloping LM curve
10.4 ‘Reconciling’ Keynes with ‘the Classics’
10.5 Unemployment–inflation data in the USA, 1960–70
10.6 Unemployment–inflation data in the USA, 1950–72
10.7 Unemployment–inflation data in the USA, 1960–80
10.8 The hog cycle
11.1 Supply and demand in the market for money
11.2 The capital market line
11.3 Investor preferences and the investment opportunity cloud
11.4 Multiple investors (with identical expectations)
11.5 Flattening the IOC
11.6 How the EMH imagines that investors behave
11.7 How speculators actually behave
12.1 Inflation and base money in the 1920s
12.2 Inflation and base money in the post-war period
12.3 Bernanke’s massive injection of base money in QE1
12.4 Change in M0 and unemployment, 1920–40
12.5 Change in M1 and unemployment, 1920–40
12.6 Change in M0 and M1, 1920–40
12.7 M0–M1 correlation during the Roaring Twenties
12.8 M0–M1 correlation during the Great Depression
12.9 Bernanke’s ‘quantitative easing’ in historical perspective
12.10 The volume of base money in Bernanke’s ‘quantitative easing’ in historical perspective
12.11 Change in M1 and inflation before and during the Great Recession
12.12 The money supply goes haywire
12.13 Lindsey, Orphanides, Rasche 2005, p. 213
12.14 The empirical ‘Money Multiplier’, 1920–40
12.15 The empirical ‘Money Multiplier’, 1960–2012
12.16 The disconnect between private and fiat money during the Great Recession
13.1 Goodwin’s growth cycle model
13.2 My 1995 Minsky model
13.3 The vortex of debt in my 1995 Minsky model
13.4 Cyclical stability with a counter-cyclical government sector
13.5 Australia’s private debt-to-GDP ratio, 1975–2005
13.6 US private debt to GDP, 1955–2005
13.7 Aggregate demand in the USA, 1965–2015
13.8 US private debt
13.9 The change in debt collapses as the Great Recession begins
13.10 The Dow Jones nosedives
13.11 The correlation of debt-financed demand and unemployment
13.12 The housing bubble bursts
13.13 The Credit Impulse and change in employment
13.14 Correlation of Credit Impulse and change in employment and GDP
13.15 Relatively constant growth in debt
13.16 The biggest collapse in the Credit Impulse ever recorded
13.17 Growing level of debt-financed demand as debt grew faster than GDP
13.18 The two great debt bubbles
13.19 Change in nominal GDP growth then and now
13.20 Real GDP growth then and now
13.21 Inflation then and now
13.22 Unemployment then and now
13.23 Nominal private debt then and now
13.24 Real debt then and now
13.25 Debt to GDP then and now
13.26 Real debt growth then and now
13.27 The collapse of debt-financed demand then and now
13.28 Debt by sector – business debt then, household debt now
13.29 The Credit Impulse then and now
13.30 Debt-financed demand and unemployment, 1920–40
13.31 Debt-financed demand and unemployment, 1990–2011
13.32 Credit Impulse and change in unemployment, 1920–40
13.33 Credit Impulse and change in unemployment, 1990–2010
13.34 The Credit Impulse leads change in unemployment
14.1 The neoclassical model of exchange as barter
14.2 The nature of exchange in the real world
14.3 A nineteenth-century private banknote
14.4 Bank accounts
14.5 A credit crunch causes a fall in deposits and a rise in reserves in the bank’s vault
14.6 A bank bailout’s impact on loans
14.7 A bank bailout’s impact on incomes
14.8 A bank bailout’s impact on bank income
14.9 Bank income grows if debt grows more rapidly
14.10 Unemployment is better with a debtor bailout
14.11 Loans grow more with a debtor bailout
14.12 Profits do better with a debtor bailout
14.13 Bank income does better with a bank bailout
14.14 Modeling the Great Moderation and the Great Recession – inflation, unemployment and debt
14.15 The Great Moderation and the Great Recession – actual inflation, unemployment and debt
14.16 Modeling the Great Moderation and the Great Recession – output
14.17 Income distribution – workers pay for the debt
14.18 Actual income distribution matches the model
14.19 Debt and GDP in the model
14.20 Debt and GDP during the Great Depression
15.1 Lemming population as a constant subject to exogenous shocks
15.2 Lemming population as a variable with unstable dynamics
17.1 A graphical representation of Marx’s dialectics
Boxes
10.1 The Taylor Rule
13.1 Definitions of unemployment
PREFACE TO THE SECOND EDITION
Debunking Economics was far from the first book to argue that neoclassical economics was fundamentally unsound.

…

Ben Bernanke, as Federal Reserve chairman, literally doubled the level of government-created money in the US economy in five months, when the previous doubling had taken thirteen years. A long decay in the ratio of government-created money to the level of economic activity, from 15 percent of GDP in 1945 to a low of 5 percent in 1980, and 6 percent when the crisis began, was eliminated in less than a year as Bernanke’s ‘Quantitative Easing 1’ saw the ratio rocket back to 15 percent by 2010.
2.2 Bernanke doubles base money in five months
The tenor of these times is well captured in Hank Paulson’s On the Brink:
‘We need to buy hundreds of billions of assets,’ I said. I knew better than to utter the word trillion. That would have caused cardiac arrest. ‘We need an announcement tonight to calm the market, and legislation next week,’ I said.

…

It was better to blame the Fed for not administering its M0 medicine properly, than to admit that the financial system’s proclivity to create too much debt causes capitalism’s periodic breakdowns.
12.2 Inflation and base money in the post-war period
It is therefore a delicious if socially painful irony that the only other time that the pop-gun fired and a depression-like event did follow was when the chairman of the Federal Reserve was one Ben S. Bernanke.
Bernanke began as chairman on 1 February 2006, and between October 2007 and July 2008, the change in M0 was an inflation-adjusted minus 3 percent – one percent lower than its steepest rate of decline in 1930–33. The rate of change of M0 had trended down in nominal terms ever since 2002, when the Greenspan Fed had embarked on some quantitative easing to stimulate the economy during the recession of 2001. Then, M0 growth had turned from minus 2 percent nominal (and minus 6 percent real) at the end of 2000 to plus 11 percent nominal (and 8 percent real) by July 2001. From there it fell steadily to 1 percent nominal – and minus 3 percent real – by the start of 2008.
12.3 Bernanke’s massive injection of base money in QE1
Whatever way you look at it, this makes a mockery of the conclusion to Bernanke’s fawning speech at Milton Friedman’s ninetieth birthday party in November 2002: ‘Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve.

But one side effect of this was to allow banks to make more profit by lending at higher rates. Money was pumped into the financial sector by another means, too: quantitative easing.
QE is not, as it is sometimes described, the printing of money, because it does not involve the physical production of notes. Instead, the Bank of England creates electronic money and then uses it to buy up government bonds. Financial institutions can then sell the bonds, adding money to their balance sheets. By 2013 the Bank of England had used quantitative easing to pump an eye-watering £375 billion into the financial system. QE proved a phenomenal subsidy for the rich – especially those with financial assets. Whilst the Bank estimated that the poorest tenth of Britain’s population each lost £779 because of quantitative easing, the richest 10 per cent enjoyed a £322,000 jump in the value of their assets.12 A study by the British macroeconomist Chris Martin found that though QE ‘produced a limited but temporary gain for the financial sector … it has been of no help to the wider business community or individuals and families struggling against inflation and unemployment’.13
Back in the 1970s, when the trade unions were wrongly scapegoated for Britain’s economic troubles, they faced exceptionally punitive measures.

Previously a
Princeton economics professor and expert on the Great Depression,
Bernanke had not only studied but also written extensively on policy
issues related to the Great Depression and certain subsequent signiﬁcant economic cycle disturbances such as the Japanese real estate collapse in the early 1990s that resulted in the so-called lost decade that
followed in the Japanese economy.39
Bernanke, like Benjamin Strong, also turned out to be a willing
and even courageous innovator in methods to advance monetary
liquidity even after interest rates had been pushed to their “zerobound.” His approach of ﬂooding the ﬁnancial system with liquidity
by undertaking several rounds of quantitative easing and by deciding
to include mortgage-backed securities instead of just US Treasuries
in open market operations received no shortage of bad press from a
variety of politicians and commentators. And yet, slowly but surely,
the credit markets were set back in motion, consumers experienced
wealth effects from reﬂating asset prices, and ﬁrms that had access
found themselves with inexpensive capital for investment projects
and eventually had the conﬁdence to use it when the smoke began
to clear.
218
Investment: A History
the fiscal response
In terms of ﬁscal policy, the ﬁnancial crisis triggered several important and substantial steps by way of ﬁscal stimulus from the Treasury.

…

Morgan (largest US savings and loan)
September 29, 2008:
Congress rejects bailout
October 3, 2008:
Wachovia Bank sold to Wells Fargo
Congress passes TARP (451 pages)
November 4, 2008:
Obama elected US president
November 23, 2008:
The Fed, Treasury, and FDIC bail out
Citigroup
December 11, 2008:
Bernie Madoff arrested
December 19, 2008:
TARP loans to GM and Chrysler
January 2009:
The Fed, Treasury, and FDIC bail out
Bank of America
February 17, 2009:
$787 billion Economic Stimulus Act
signed
March 2009:
QE1 (ﬁrst Fed quantitative easing)
April 30, 2009:
Chrysler ﬁles for bankruptcy
June 2009:
Great Recession ends
July 21, 2010:
Dodd-Frank Reform Act signed
November 2010:
QE2
November 18, 2010:
GM emerges from bankruptcy with
IPO
September 2012:
QE3
c h a p t er se v en
The Emergence of
Investment Theory
IT IS STAMPED ACROSS THE NEWSPAPER. It is mentioned
in short sound bites among radio broadcasts. It is discussed at length
in the nightly news.

As long as the markets could be genetically modified by the Fed, the economy would look healthier than it actually was.
Many experts have argued that an environment like what we’ve seen since 2008, in which borrowing costs are as low as they’ve ever been, is the perfect time to build bridges, fund new basic science research, or revamp public schools. Yet thanks to congressional gridlock, it didn’t happen. The Federal Reserve alone was able to act to support the economy, with lower rates and quantitative easing (which is essentially pumping money into the economy in the hopes of boosting asset prices and consumption). But one of the many fascinating and downright disturbing things about the current boom in shareholder activism is that it was actually enabled by monetary policies that were supposed to help the little guy. Following the financial crisis, the Fed cut interest rates to historic lows and carried out a massive bond and mortgage-backed securities buying program.

…

The money stays in the financial sector, in other words, instead of being invested in the real economy that we live in. The Fed had hoped that rising asset prices would lead to growing consumer confidence, which would spur business investment in the real economy, boost the demand for labor, and eventually get that virtuous cycle of job creation started. But it didn’t work that way. While quantitative easing has helped lift the job market somewhat at the lower end of the socioeconomic spectrum (one big reason that companies like Walmart have raised their wages by a dollar or two per hour), it has done almost nothing for the middle class.
There are two reasons why. The first is that, as I’ve explained above, companies didn’t take advantage of low borrowing rates in order to invest in Main Street; they did it to buy back stock and enrich corporate leaders and investors.

…

It was a shift that was due to several things: the creation of a commodity index fund by Goldman Sachs in 1991, which allowed raw materials to become securities that could be bought and sold by investors; the deregulation of commodities markets in 2000, which poured gasoline on that process; the financial crisis of 2008, which scared everyone out of stocks and drove investors into “safety” bets like raw materials; and the beginning of the Federal Reserve’s quantitative easing program the following year, a $4.5 trillion money dump that was meant to help Main Street but ended up giving Wall Street a lot of easy money to burn. Much of that money ended up in commodities markets, dramatically boosting the prices of those commodities—the raw materials that people depend on to heat their homes, fill up their gas tanks, and feed their families. For many people around the world, this made something as basic as eating literally unaffordable.

“Credit spreads” — the difference between yields on safe government debt and riskier corporate debt — “are much wider and credit markets more dysfunctional in the United States than they were during the Japanese experiment with quantitative easing,” Bernanke said.
Bernanke wanted to continue to bypass the banking system and lend directly in markets — mortgages, commercial paper, student loans — where usually high interest rates indicated the supply of credit was inadequate to meet the demand. To distinguish the Fed’s approach from the Bank of Japan’s, he wanted to call it something other than “quantitative easing.” He and the other Musketeers bandied about alternatives. Warsh offered “qualitative easing,” but that didn’t fly. In the end, they embraced “credit easing,” a phrase Bernanke introduced into the jargon of monetary policy in his first major speech following the December FOMC meeting.

…

Instead of lending that is targeted at any particular market, the dissenting presidents wanted the Fed to simply use U.S. Treasury bonds to put reserves into the system and let the money flow to where it was needed.
It was an approach similar to one developed during the previous decade in Japan. To resuscitate the economy and fight deflation, the Bank of Japan had first dropped interest rates to zero and then, with mixed results, increased the supply of reserves. This policy, called “quantitative easing” — because it emphasized the quantity rather than the price (interest rates) of money — suited the ideology of several Fed presidents. The Fed would control how much money was in the financial system but wouldn’t influence where it went and for what it was used — that would be up to the markets. It also gave the presidents a say: they wanted a vote on how much credit the Fed was pumping into the economy.

When the global recovery got under way in 2010, the poor were hit by price rises, occurring in the first place because, since 2000, all global recoveries have sparked commodity price inflation; and secondly, because the USA had decided to unleash inflation onto the developing world.
As the effects of Obama’s stimulus faded, in November 2010 Ben Bernanke began a second round of money printing—$600 billions’ worth—known as ‘Quantitative Easing II’. QEII, it was recognized even at the design stage, would not increase demand directly in America. By reducing the value of the dollar, and the attractiveness of dollar investments, it would create an international ‘wall of money’ flowing out of the USA towards its emerging rivals: Russia, Brazil, India and other dynamos of the global south. Those countries’ currencies would have to rise against the dollar, or they would have to tolerate rampant inflation, or both.

Once these bonds lost value, European banks increasingly found themselves shut out of US wholesale funding markets at the same time that US money markets began dumping their short-term debt. What happened in the United States in 2008, a general “liquidity crunch,” gathered pace in Europe in 2010 and 2011. It was only averted by the LTROs of the ECB in late 2011 and early 2012. This unorthodox policy of quasi-quantitative easing offered only temporary respite. Paul De Grauwe called it “giving cheap money to trembling banks with all the problems this entails.”68 The results were that within two months of the first LTRO by the ECB, sovereign bond yields were rising again, and the banks those sovereigns were responsible for now had even more sovereign debt on their balance sheets—a fact not lost on investors now worrying about Spain and Italy.

…

Hume’s claims do not echo today’s—today’s claims are direct replicas of Hume’s. For debt being politically easier than taxes, look no further than Northern European criticisms of the budget policies of Greece and Italy.20 For government debt crowding out other investments, see the plethora of criticisms of the Obama stimulus.21 For debt driving up prices and compromising the ability of the state to cushion further shocks, see the voluminous criticisms of quantitative easing and fears that a spike in US interest rates will cause exactly that.22 For the fear of foreigners owning the United States, simply google “China owns USA.” The search returns 25 million hits even though the statement is simply not true—foreigners hold less than one-third of outstanding US debt.23
Despite this broadside of familiar critiques, we must remember that Hume predicted the end of Great Britain due to excessive debt issuance just at the moment that Great Britain was about to dominate the world for a century.

…

It was the longest equity bull market in history, and it spread out from the United States to boost stock markets all over the world. The smart cash that was being made in those equity markets looked around for a hedge and found real estate, which began its own global bubble phase in 1997 and ran until the crisis hit in 2006. The final bubble occurred in commodities, which rose sharply in 2005 and 2006, long before anyone had heard the words “quantitative easing,” and which burst quickly since these were comparatively tiny markets, too small to sustain such volumes of liquidity all hunting either safety or yield. The popping of these interlinked bubbles combined with losses in the subprime sector of the mortgage derivatives market to trigger the current crisis. A picture again is useful. In figure 7.1 we see these three asset bubbles (Dow Jones Stocks, S&P’s Case-Schiller Index of Housing, and gold/oil prices) scaled against time.

Signed by a long list of economists and commentators, including the Harvard economic historian Niall Ferguson and Amity Shlaes of the Council on Foreign Relations, the letter calls on the Federal Reserve to stop its policy of large-scale asset purchases known as “quantitative easing” because it “risk[s] currency debasement and inflation.” The advice was ignored and quantitative easing continued. But in the years that followed, the US dollar wasn’t debased and inflation didn’t rise. The investor and commentator Barry Ritholtz wrote in 2013 that the signatories had been proved “terribly wrong.”5 Many others agreed. But there was an obvious response: “Wait. It hasn’t happened yet. But it will.” Ritholtz and the critics might argue that in the context of the 2010 debate, the letter writers expected currency debasement and inflation in the next two or three years if quantitative easing went ahead. Perhaps—but that is not what they wrote. The letter says nothing about the time frame.

“The extent and continuing increase in income inequality in the United States greatly concern me,” Bernanke’s successor Janet Yellen remarked in 2015, after seven years of quantitative easing policy. “The past several decades have seen the most sustained rise in income inequality since the nineteenth century.” Even with more money floating around, there was, paradoxically (at least using traditional thinking), less demand.
But that wasn’t the whole story. Networks were also working insidiously on the supply side of the equation. Remember that markets always set prices by balancing supply and demand. On a hot day when more people want lemonade, the kids on the beach selling it can charge more than on a rainy day. In the years after 2008, much of the cheap credit of “quantitative easing” was used to fund projects that massively increased supply. More oil rigs were built. A whole fracking industry was financed on cheap credit.

…

Bernanke’s reaction to the 2008 financial crisis—and the path of most of his fellow central bankers around the world—was what you would have expected, then: to avoid that fatal financial distress by flooding the system with money. “I was not going to be the Federal Reserve chairman who presided over the second Great Depression,” he reflected in 2009. The U.S. monetary base grew fivefold, from $800 billion to $4 trillion, as a program known as “quantitative easing” pressed money into circulation. But something unusual and unnerving became apparent after a few years. Despite massively increasing money supply, prices remained largely the same. Consumption remained stagnant. Usually the injection of tremendous amounts of money into the system creates demand, it builds pressure for inflation: Suddenly everyone has money and wants to spend it. “Inflation is always and everywhere a monetary phenomenon,” the Nobel Prize–winning economist Milton Friedman famously said.

pages: 275words: 84,980

Before Babylon, Beyond Bitcoin: From Money That We Understand to Money That Understands Us (Perspectives)
by
David Birch

Subsequent Chinese rulers, unburdened by Kublai’s fiscal rectitude, were responsible for the most dangerous implementation of the technology of paper money: the fractional reserve. They calculated that so long as the merchants believed in the paper money, it didn’t actually matter if there was any gold or silver or gems or pearls in the imperial strongroom. They therefore succumbed to the inevitable temptation of quantitative easing and began to print money willy, and very probably, nilly. Their paper currency system eventually collapsed in hyperinflation (as I suppose they all do in the end) in the fourteenth century and was not independently rediscovered by the next great crucible for monetary experiment – the New World – until the Massachusetts Bay Colony began to issue fiat paper in 1698.
Around the same time as the technology of paper money was rebooted, the last great monetary innovation of the pre-modern age, central banking, arose around the coffee houses of Amsterdam.

…

In total, the prisoners forged around £132 million, which is about four billion quid at today’s prices.
A genuine fake banknote from Sachsenhausen.
Now, printing four billion quid’s worth of worthless paper money not backed by anything might sound like a reasonable way to destabilize the economy, but I don’t think it would have worked. Following the recent financial crisis, under what is now known as ‘quantitative easing’ (QE) rather than ‘counterfeiting’, the Bank of England printed more than two hundred billion imaginary pounds (i.e. fifty times as much as the Nazis) and rather than crash the economy, they stabilized it. Many other central banks have also done this on a large scale. And yes, I know, QE isn’t actually printing. It takes the form of asset purchases, mainly from non-bank financial companies, which serve to increase the amount of money in circulation.

…

It achieves this by adding to bank balances (i.e. those of the companies that the assets are purchased from) because, as we will discuss in Part III, money is actually created by commercial banks, not central banks (McLeay et al. 2014).
It is impossible not to observe that some people think that Hitler’s roll-out method (i.e. dropping the money from planes) would have had a more positive impact on economic growth than the method used by many central banks (i.e. giving the money to banks who, by and large, kept it). So is quantitative easing a sound government policy or a secret plot to destroy our economy? Were the Khan’s successors printing real or counterfeit money? That depends on your perspective. I will leave the topic by highlighting the final supreme irony of Hitler’s attempt to ruin sterling: Laurence Malkin points out that after the war the Jewish underground passed on thousands of the counterfeit banknotes to help Holocaust survivors fleeing to the British Mandate for Palestine and purchasing war matériel for the nascent Israeli army (Malkin 2008)

When the Fed’s Ben Bernanke, an expert on the Depression, injected hundreds of billions of dollars of liquidity into the economy in 2008–9, Lucas applauded the action.9 President Obama’s initial fiscal stimulus package of 2009 also received widespread support (including from Lucas), even if viewed as a desperate, last-resort measure.‡
Beyond these measures, and once the financial panic subsided, the new classical models suggested restraint and caution and not much else. The Fed’s policies of quantitative easing—its monetary expansion—had to be withdrawn quickly; otherwise, it soon would lead to inflation. Economists trained on these models kept warning about the dangers of inflation and urged the Fed to tighten its policy, even though unemployment remained high, the economy performed below par, and—notably—inflation refused to appear. They argued against continued fiscal stimulus to lift aggregate demand and employment, since such measures would only crowd out private consumption and investment.

States with weak public ﬁnances lose debt
market access and veer toward default (with Greece being the poster boy this
time around). Meanwhile, regulatory capital rules—as well as risk aversion to
the real economy and lack of loan demand by shell-shocked enterprises and
households—have stuffed bank balance sheets with sovereign bonds. Central
bank balance sheets are whole multiples of pre-crisis levels due to bad asset
purchases and “quantitative easing”—central banks creating money to buy
debt securities.
Scene Ten
The ﬁnance crisis seems contained, and states and banks hope for a return
to something resembling pre-crisis conditions or recovery while they continue to patch over difﬁculties ad hoc (e.g., Greece, Ireland, US house prices).
Recovery in the real economy and meaningful reductions in unemployment
remain elusive. Markets swing wildly from hope (risk-on) to fear (risk-off) on
political or corporate-earnings news.

In June 2014 it made history by doing what no central bank has done outside a major financial crisis—that is, pushed the rate on bank deposits to a negative level. In January 2015, the central bank went even further, committing to large-scale purchases of market securities that would expand its balance sheet by 1 trillion euros.
In what The Wall Street Journal loudly proclaimed on its January 23 front page was a “new era” (Figure 4), the ECB had embarked on a large and relatively open-ended quantitative easing (QE). It reaffirmed the use of the asset channel as a means of countering deflationary expectations and low growth. And to stress its seriousness, President Draghi indicated in the ECB press conference that the central bank stood ready to buy bonds at negative yields (yes, negative), and it did.
This was quite a statement from a central bank known historically for its reluctance to venture even an inch away from orthodoxy; and for an institution whose decision-making Governing Council has to strike difficult political compromises while retaining the support of the famously conservative Germans.5
Throughout all this, markets have rejoiced at the continuing engagement of central banks, institutions that became investors’ best friends.

…

As such, the political statement would end up being disappointing, expensive, and short-lived, in addition to potentially harming more promising initiatives in the future. On the other hand, should these conditions be met, the BRICS could end up providing a catalyst for revamping multilateralism in a manner that promotes global economic cooperation and prosperity.
CHAPTER 15
THE MIGRATION AND MORPHING OF FINANCIAL RISKS
“Quantitative easing has been a bold and innovative experiment. Its outcomes were always uncertain, and some may have been unfortunate. But central banks have been right to do what they did.”
—FINANCIAL TIMES
Issue 7: With systemic risks migrating from banks to nonbanks, and morphing in the process, regulators are again challenged to get ahead of future problems.
Undoubtedly, the banking system in advanced economies is now safer—a lot safer.

When money commodities are represented by numbers, this introduces a serious and potentially misleading paradox into the monetary system. Whereas gold and silver are relatively scarce and of constant supply, the representation of money as numbers allows the quantity of money available to expand without any technical limit. We thus see the Federal Reserve in our time adding trillions of dollars to the economy at the drop of a hat through tactics like quantitative easing. There seems no limit to such possibilities except that imposed by state policies and regulation. When the metallic basis of global moneys was totally abandoned in the 1970s, we indeed found ourselves in a potentially limitless world of money creation and accumulation. Furthermore, the rise of moneys of account and even more importantly of credit moneys (beginning with the simple use of IOUs) places a great deal of money creation in the hands of individuals and the banks rather than in the hands of state institutions.

…

This is so only because the money form is now unchained from any physical limitations such as those imposed by the money commodities (the metallic moneys like gold and silver that originally gave physical representation to the immateriality of social labour and which are largely fixed in terms of their global supply). State-issued fiat moneys can be created without limit. The expansion of the contemporary money supply is now accomplished by some mix of private activity and state action (via the state–finance nexus as constituted by treasury departments and central banks). When the US Federal Reserve engages in quantitative easing it simply creates as much liquidity and money as it wants at the drop of a hat. Adding a few zeros to the quantity of money in circulation is no problem. The danger, of course, is that the result will be a crisis of inflation. This is not occurring because the Federal Reserve is largely refilling a hole left in the banking system when trust between the private banks broke down and interbank lending, which was leveraged into massive money creation within the banking system, broke down in 2008.

Mainly relegated to jewelry (about 70% of annual demand),
gold’s value is mainly set by its utility as a commodity. Upon the occasional lapses when faith in government obligations has waned, especially in the context of inflation, its value was partially restored, because
citizens saw it as an alternative to fiat currency. However, it held up
well through much of the 2008 panic, but its strength then was correlated with fears of debasement when monetary authorities discussed
quantitative easing or injected reserves. The thesis that gold should
decline in price when deflation occurs is contradicted by the history
The Rise and Fall of Hard Money
69
of the metal having roughly doubled its purchasing power in the early
1930s. Silver was once the preeminent form of specie, but for a century
its value relative to gold has remained depressed. The advent of goldbacked ETFs portends a permanent threat to silver, because divisibility is now possible, which might enable broad usage of a 100 percent
backed gold currency.

…

Those who rooted for the deflationist camp looked to
the depression years and saw a consumer heavily laden with debt and
a highly leveraged banking system wherein over half of its loans relate
to real estate.6 They saw interest rates at generational lows already, with
the Fed discount rate near zero by year-end 2008. With loan demand
sated and a need for banks and consumers to deleverage, they saw any
Fed action to inject reserves into the monetary system as “pushing on
a string,” to use the phrase invented by the monetarist Friedman in his
analysis of the Great Depression.
From within the Fed in the days that the policy of quantitative
easing became official, Philadelphia Federal Reserve Bank President
Plosser alerted us that “(recent economic statistics) prompted some
commentators to suggest that the United States is facing a threat of
sustained deflation, as we did in the Great Depression or as Japan faced
for a decade. I do not believe this is a serious threat … (but) the Fed
must credibly commit to preventing sustained deflation from becoming widely anticipated, just as it must prevent sustained inflation from
becoming widely anticipated.”7 All this is well and good.

…

By early 2009 the Fed would target 2 to 3 percent inflation, explicitly stating it would intervene in the open market to buy Treasuries,
hoping that recipients of federal spending would deposit freshly printed
funds at banks, stimulating lending. These more aggressive moments of
market intervention would epitomize the gearing up of the printing
press technology to which Bernanke refers. It might lead to nominal
growth in the economy, but it remains to be seen if real growth or
wealth creation would ensue.
However, in the momentous meeting in which quantitative easing
was ratified, FOMC members thought that this extraordinary measure
could be undone. Meeting notes declare: “as economic activity recovered and financial conditions normalized, the use of certain policy tools
would need to be scaled back, the size of the balance sheet and level of
excess reserves would need to be reduced, and the Committee’s policy
framework would return to focus on the level of the federal funds rate.”

It’s not often that one sees central bankers on the ramparts, but Yellen’s promise overlooked the role the Fed itself was playing in turbocharging the rise of billionaires worldwide. The rise in inequality had been particularly dramatic for measures of wealth rather than income, and the Fed had been instrumental in fueling wealth on Wall Street not Main Street. To boost growth following the global financial crisis of 2008, the Fed pumped record amounts of money into the U.S. economy through multiple rounds of “quantitative easing,” which involved buying bonds on the public markets. The hope was that this infusion of capital would promote a strong recovery and job growth. Instead, the United States experienced its weakest recovery of the postwar era, coupled with an unprecedented period of financial speculation.
Much of the Fed’s easy money was diverted into purchases of stocks, luxury homes, and other financial assets, as well as into financial engineering (like share buybacks) designed to further increase the price of those assets.

…

When other central banks matched the Fed’s easy money policies, they helped to feed the growing wealth gap in their own countries, too. In a 2014 study of 46 major countries, the research arm of the bank Credit Suisse found that before 2007, wealth inequality was on the rise in only 12 of those countries; after 2007, that number more than doubled to 35, from China and India to Britain and Italy.1
The easy money experiments began in 2008, and by the time quantitative easing ended in 2014, the richest 1 percent of the world’s population had increased its share of global wealth from 44 to 48 percent of the total, which had risen to $263 trillion. A 2014 study by the Pew Research Center found that “the wealth gap between America’s high income group and everyone else has reached record levels since the Great Recession of 2007–2009,” with wealth rising for upper-income families and stagnating for the middle- and lower-income groups.2 The high-income families were 3.4 times wealthier than middle-income families in 1983, and while that gap widened gradually over the next quarter century to 4.5 times wealthier in 2007, it widened rapidly to 6.6 times wealthier in 2013.

…

This is another form of state meddling—interfering to fix the price of a currency is like interfering to fix any other price in the market, which often punishes such attempts.
It’s particularly difficult for a country to devalue its way to prosperity if every other country is trying the same trick. After the crisis of 2008, so many nations tried to improve their competitive position by devaluing their currencies that none managed to gain any lasting advantage. The central banks of the United States, Japan, Britain, and the Eurozone took turns pursuing “quantitative easing” policies that effectively amount to printing more money, in part as a way to devalue their currencies, but each achieved at best a brief gain in export share versus the others.
Markets can punish these attempts to manage currency values in many ways. The most important is that if a country has borrowed heavily in dollars or euros or some other foreign currency, then devaluing its own currency by, say, 30 percent is going to raise its payments on those foreign loans by an equal margin.

Tony is a rational and strong-minded guy, but I don’t think he would be able to admit that Iraq was a mistake. It would be too devastating, even for him.”
III
In November 2010, a group of renowned economists, high-profile intellectuals, and business leaders wrote an open letter to Ben Bernanke, then chairman of the Federal Reserve.7 The bank had just announced its second tranche of so-called quantitative easing. They proposed to purchase bonds with newly printed money, introducing, over time, an additional $600 billion into the U.S. economy.
The signatories were worried about this policy. In fact, they thought it might prove disastrous. In the letter, which was published in the Wall Street Journal, they argued that the plan was not “necessary or advisable under current circumstances” and that it would not “achieve the Fed’s objective of promoting employment.”

…

Boskin, the former chairman of the president’s Council of Economic Advisers; Seth Klarman, the billionaire founder of the Baupost Group, an investment company; John Taylor, professor of economics at Stanford University; Paul Singer, the billionaire founder of Elliott Management Corporation; and Niall Ferguson, the renowned professor of history at Harvard University.
Perhaps their greatest concern was over inflation, the fear that printing money would lead to runaway price increases. This is a worry often associated with economists within the “monetarist” school of policymaking. The signatories warned that quantitative easing would risk “currency debasement and inflation” and “distort financial markets.”
The letter, which was also published as a full-page ad in the New York Times, made headlines around the world. The fears were well expressed, well argued, and the prediction of trouble ahead for the U.S. economy caused a minor tremor in financial markets.
But what actually happened? Did the prediction turn out to be accurate?

Subbarao responded with a mixture
of running down reserves and letting the rupee depreciate. So far, his
policy was entirely in consonance with Reddy’s. Then, strong inward capital flows resumed because a) it looked as if the worst of the crisis was
over and India had come out of it in better shape than many countries;
and b) Western governments slashed interest rates to very low levels and
started ‘quantitative easing’, which raised the relative return on Indian
assets. At this point, Subbarao appears to have had a change of heart.
Perhaps he thought that a stronger rupee would be good for damping
down inflation. Perhaps he was persuaded by the reports of some government committees that had advocated moving towards a floating exchange
rate. He turned away from Reddy’s strategy of managing the rupee and
allowed the exchange rate to be market-​determined.

…

This is a case where the IMF’s position has moved
closer to India’s over the years. The IMF now recognizes that capital controls may be necessary to defend national financial stability. The East Asian
crisis of 1997 was partly responsible for the change of view. More recently,
in the aftermath of the GFC, this was reinforced by the experience of the
highly expansionary monetary policies (including so-​
called ‘quantitative easing’ [QE]) that were undertaken by central banks in the advanced
countries. When the US Fed introduced the second round of QE in 2010,
many emerging counties were threatened with huge and disruptive capital inflows. Several of them (e.g. Brazil, South Korea, Thailand, Indonesia)
introduced capital inflow controls to prevent their currencies from rising to
uncompetitive levels. (On this occasion, India did not do so, and paid for it
dearly, as seen in Chapter 8.)

I knew I wouldn’t have that luxury for long.
As I prepared to leave the New York Fed, it was hard to fathom how much we had done since the crisis began, and how much the financial world had changed.
The Fed had overseen an aggressive easing of monetary policy, reducing our target interest rate from 5.25 percent in September 2007 to as close as it can go to zero in December 2008. Ben had also launched a “quantitative easing” program, buying bonds to provide further monetary stimulus for the economy. We had expanded the Fed’s balance sheet from $870 billion to $2.2 trillion with our new credit and liquidity programs, extending our lending far beyond the U.S. commercial banking system, financing a broad range of collateral for a broad array of nonbanks. We were lending hundreds of billions of dollars to the financial system every day, supporting the tri-party repo market and backstopping the commercial paper market, while the Treasury was guaranteeing money market funds.

…

But the financial system is the conduit between the Fed and the economy, and the financial system was broken. In an epic financial crisis that followed a major credit boom, easy money had much less power. Interest rates were already effectively zero; most banks had little ability and even less desire to lend; businesses had little desire to borrow; and consumers already had too much debt. As central bankers say, it felt like the Fed was pushing on a string. It had begun the first round of quantitative easing, or QE1, buying GSE mortgage bonds to help reduce the cost and increase the availability of mortgages. This was an innovative way to do monetary stimulus at a time when short-term rates were as low as they could go; the Fed would later expand the program to Treasuries to try to drive down long-term rates more generally. It was helpful at a time when the economy was still struggling, but it would not be enough on its own.

…

The playbook for monetary and fiscal policy is fairly simple. You want to be as expansive as possible, providing substantial stimulus for the economy for as long as necessary. After a major shock that depresses demand and creates a risk of deflation, central bankers should ease monetary policy, aggressively lowering interest rates. Once the overnight rate approaches zero, they should find new ways to stay on the accelerator, as Ben did through quantitative easing. They need to signal that they’ll eventually hit the brakes, and that they’ll remain vigilant about inflation going forward, but the threat of future inflation is much less worrisome than the threat of imminent deflation and depression. Loose monetary policy can have limited power in a crisis, because low interest rates don’t help that much when borrowers don’t want to borrow and lenders don’t want to lend, but as the central bankers of the 1930s demonstrated, tight monetary policy can be disastrous.

Currently, we have a situation where there is a broad global deleveraging, which is negative for growth. Debtor countries that can print money
will behave differently from those that can’t. Countries that can’t print money will experience classic deflationary depressions. Those that can
print money, such as the United States, can alleviate the deflation and depression pressures by printing money. However, the effectiveness of
quantitative easing will be limited because the owners of the bonds that are purchased by the Fed will use the money to buy something similar;
they are not going to use it to buy a house or a car. In addition, fiscal stimulus will be very limited because of the reality of the political situation.
So it is unlikely that we will have effective monetary policy or effective fiscal policy. That means we will be dependent on income growth, and
income growth will be slow—maybe about 2 percent per year—because income growth is usually dependent on debt growth to finance buying,
and I don’t expect any significant private credit growth.

…

The market will remain “locked” limit down until the futures
price reaches the cash market price. The episode Ramsey is referring to represents the longest string of consecutive limit down days that has
ever occurred in any futures market.
4John Murphy, Technical Analysis of the Futures Markets (New York: New York Institute of Finance, 1986).
5Strong economic conditions are bearish for bonds because they lead to higher interest rates.
6QE2 was the Fed’s second round of quantitative easing (buying longer-duration treasuries and other securities to lower longer-term rates)
that began in November 2010 and ended in June 2011.
7In a Turkish lira/dollar chart, a new low in the lira would show up as a new high—that is, it would take more lira to buy each dollar.
8Ramsey is referring to the chart. So a relative low would represent a point of relative lira strength—that is a point at which it took less lira to
buy one dollar than in prior or succeeding days.

…

I watch various economic statistics, including more esoteric data such as weekly rail car loadings. When the data points to a slowdown, I might
reduce my exposure. If I am concerned enough, I may even move to almost all cash. This attention to economic indicators helped me in 2002
and in 2008. Although in 2010, the same cautionary approach cut my profits. I sold a number of stocks on the notion that the economy was in
trouble, and then the Fed initiated QE2 [that is, a second phase of quantitative easing], and stocks took off. I was up 13.3 percent net in 2010,
but I would have been up a lot more if I hadn’t liquidated in response to my concerns about the economy. I have no regrets, though, because I’d
rather miss an opportunity than lose money.
During the long bear market in 2000 to 2002, did you have low exposure the whole time?
I had very low exposure, and I was very patient.
How low?

While the holdings of each portfolio would mirror those of the other Paulson funds, the investments would be denominated in gold as opposed to dollars, allowing for investors to benefit from both the expected rise in value of the portfolio as well as the expected rise in the value of gold versus the dollar over time. Investors that opted for the gold share class earned any dollar returns, plus any incremental returns in the appreciation of gold versus the dollar.
In 2009, Paulson and his credit team were closely monitoring government actions to stimulate the economy and aid the recovery. When the Fed adopted quantitative easing as a tool for monetary stimulus Paulson became concerned about the potential for future inflation and dollar depreciation.
Quantitative easing historically had not been used in the United States and was a very unorthodox monetary tool, but the United States had entered into a financial crisis that was deeper than any since the Great Depression. And it required innovative and unusual thinking in order to stem the crisis and return the country to recovery. “Due to our concerns about the dollar, we started to look for another currency in which to denominate our investments,” says Paulson.

Her recipe for success combined explaining economics with simple, easy to understand advice, while holding government officials’ feet to the fire when necessary. She offered counsel on household budgets and college savings, and both scolded and advised presidents. She eschewed what she called “bafflegab,” the sorts of terms people who like to sound smart use even though they obscure the facts. (If you are looking for a modern day example of bafflegab, think of the currently popular term “quantitative easing.” Porter probably would have referred to it as “printing money.”*) “Why can’t [my] economists talk straight like Sylvia,” President Lyndon Johnson once said in exasperation.
Porter was not without critics. “Economics by eye-dropper,” carped one anonymous New York University professor to Time, decrying her simplification of complex topics. Yet if Porter hadn’t come up with the basic personal finance formula, it’s likely someone else would have eventually done so.

…

You can lose half your wealth,” he said to the knowing laughter of the crowd.
When the floor opened for audience participation, I realized women are asking the same questions I hear at almost every financial seminar I attended, either in person or via webinar, the seminars where the vast majority of attendees are almost always male. “How would you recommend the average investor prepare for the end of quantitative easing?” asked one. Another inquired how asset allocation fit in with risk management since pretty much all categories of investment had fallen significantly during the 2008 economic crash. About the only thing female-specific about this session is that the vast majority of the attendees and all of those asking questions were women.
A few weeks before the Citi breakfast, I met with Linda Descano, who I admit I liked immediately.

It was against this background that President Obama declared late in 2013 that the basic bargain at the heart of the American economy had frayed, as increasing inequality combined with declining upward mobility posed a fundamental threat to the American dream, to Americans’ way of life and to what the US stood for around the globe.213
Inequality has been further increased by the measures adopted by central bankers to address the aftermath of the financial crisis. Asked in 2012 by the UK’s parliamentary Treasury Select Committee to highlight the redistributional impact of its asset-purchasing programme – so-called quantitative easing – the Bank of England explained: ‘By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds, but holdings are heavily skewed with the top 5 per cent of households holding 40 per cent of these assets.’
The Bank emphasised its belief that without its asset purchases, most people in the United Kingdom would have been worse off because economic growth would have been lower, unemployment would have been higher and many more companies would have gone out of business.

…

The Bank emphasised its belief that without its asset purchases, most people in the United Kingdom would have been worse off because economic growth would have been lower, unemployment would have been higher and many more companies would have gone out of business. That would have had a significant detrimental impact on savers and pensioners, along with every other group in society. A rise in inequality should obviously be seen in that light. Yet there is no escaping the fact that the rich have been the biggest beneficiaries. In the words of Marc Faber, an influential Asia-based investment strategist, quantitative easing funnels money to the ‘Mayfair economy’ of the well-to-do and ‘boosts the prices of Warhols’.214
In continental Europe, the increase in inequality is less pronounced. Yet there is angst in the eurozone about inequality and imbalances between countries. As we saw in the previous chapter, northern Europeans resent a monetary union that has permitted southern Europe to engage in what they see as fiscally profligate behaviour, while southern Europeans and the Irish are required to submit to extreme austerity programmes that exacerbate their sovereign debt problems and keep living standards depressed.

This applies to the newly founded Bamboozl.com, so it’s going to have great success. Bamboozl goes bust, but I’m going to be able to come up with any number of reasons for its failure. Management was not as talented as I had thought. The competition moved much faster than could have been predicted.
I believe that announcement of a cutback of “quantitative easing” by the Federal Reserve will result in fear in the equity markets, causing a drop in stock values. The Fed announces a slowdown of quantitative easing and the markets go up. Because of … you name it.
Jennifer, disorganized in her private life, would never make a good newspaper editor, a job that requires meeting deadlines and simultaneously juggling information obtained from Internet sources, assigning tasks to copy editors, and so on. Lo and behold, she turns out to be an excellent editor.

When the music stopped playing, the world stood on the brink of the worst economic calamity since the 1930s. And the crisis introduced a new vulnerability into the system: as central banks worked to buoy demand, they slashed their interest rates to zero or, in some cases, to negative rates. Central banks are not entirely without options once rates fall so low. They can keep cutting, a bit, or they can print money to buy assets such as government bonds (a stimulative procedure known as quantitative easing). But these options are limited in a number of ways: as interest rates become increasingly negative, for instance, households have an incentive to shift more of their savings to cash – to keep their money in shoeboxes or safe-deposit boxes, where negative rates do not apply. Central banks themselves are also wary of acting aggressively in using these ‘unconventional’ policy tools: they worry about risks known and unknown.

Lazzarato explains this in relation to the 2010 Bush–Obama law that
extends the tax cuts to those making more than $250,000. The income bracket represents only 5% of the population … in exchange for peanuts for the unemployed, the rich received $315 billion over two years. To have an idea of the handout, one should remember that the US government investment in the economy came to $800 billion in 2008. (Lazzarato, 2012: 119–20)
The current policy of quantitative easing (the governmental allocation of money for big business) fulfils a similar purpose that is perhaps even more striking in its ‘trickle up’ characteristics.
Here the capitalist state is directly fostering conditions that make work a permanently present problem that merits our practical attention: (a) we now have to pay for the resources that the collective tax pool used to take care of, and (b) our work is no longer about making a living but about avoiding social catastrophe.

The Federal Reserve’s primary function is to protect the wealthy—those who are holding cash—by preventing the inflation that would make that cash less valuable. During hard times, a compassionate central bank can choose instead to pump more money into the economy—but it really has only two ways to accomplish that. It can lend money to banks at the lowest interest rate possible—even zero—or it can buy the banks’ stashes of bonds (what’s known as “quantitative easing”). But for this money to reach the real economy, the banks still have to lend it to people and businesses. Nothing is forcing them to do that part, and in a low-interest environment, their profit margins on lending are squeezed anyway. Most banks would rather invest the money in more leveraged financial instruments or buy the stock of existing companies. Moreover, given the slow-growth economy, many banks refuse to take money from the Fed, loath to take on credit that they know they’ll have to pay back.

Financiers never hesitate to lend to a prosperous concern.”8
In response to the GFC, central banks reduced official rates to historical lows, often to zero (known as ZIRP, or zero interest rate policy). When the ability to change the price of money (that is, the interest rate) became restricted as the rate went to zero, central banks increased the quantity of money, in a process known as quantitative easing (QE).
If an economy is cash-based, this means printing money. In Weimar Germany, the government took over newspaper presses to print money to meet demand for banknotes. In modern economies, the process requires central banks to purchase securities, primarily government bonds, to inject liquidity into the financial system.
The balance sheets of major central banks expanded from around US$5–6 trillion prior to 2007/08 to over US$18 trillion.

…

The strategy was to allow prices to fall below the production costs of high-cost producers and non-traditional oil sources, especially shale, forcing them out of business and thus protecting Saudi's and OPEC's market share.
Some argued that oil prices had entered a new, permanent long-term range of US$20–60 per barrel. Others saw the fall as temporary. The consensus was that lower oil prices would assist the global economy. Quantitative greasing would augment quantitative easing, supporting economic activity. A US$40 fall in oil price equates to an income transfer of around US$1.3 trillion (around 2 percent of global GDP) from oil producers to oil consumers. The 50 percent fall in 2014 was expected to boost global growth by around 1 percent.
The essential assumption is that a lower oil price increases GDP by shifting income from producers to consumers, making them more likely to spend.

The ECB’s president, Mario Draghi, countered in Coeuré’s defense that increase in government debt purchases had already been obvious from the figures published on the ECB’s website over several preceding days but promised to improve the bank’s communication policy.
Asymmetrical or unequal access to information regarding the bailouts during the financial crisis gave rise to the suspicion that Wall Street capitalized on an unfair advantage. Particular attention was paid to the Fed’s 2008 hiring of four private asset management companies—PIMCO, Black-Rock, Goldman Sachs, and Wellington—to help implement its quantitative easing program. Lacking the necessary expertise and infrastructure to implement the enormous program itself, the Fed had to rely on third-party managers and provided the retained firms with nonpublic information so they would understand how to proceed. That posed a potential conflict of interest, because those firms traded in the same securities on behalf of their clients that they bought for the Fed.

…

His students also included former U.S. treasury secretary Larry Summers and Greg Mankiw, who chaired the Council of Economic Advisers during the administration of George W. Bush. Fischer had also been in the running to become IMF chief when Dominique Strauss-Kahn resigned, and Fed chairman after the end of Bernanke’s term. Fischer’s, Bernanke’s, and Draghi’s aligned thinking was reflected in their similar approach to quantitative easing during the financial crisis and in its aftermath. The central bank governor of the Bank of England during the crisis was Mervyn King, who had also once taught in MIT’s economics department. It is quite incredible how much our world has been shaped by the few who attended the same school.
The epitome of the old boys’ network is Goldman Sachs. It is the most exclusive of all exclusive clubs and artfully illustrates how the power-laws of network science correlate with actual network power.

Less than a week after his speech, Roosevelt submitted the Emergency Banking bill to Congress, which passed it the same day. The new law was designed to allow bank regulators to figure out which banks were solvent and could reopen, with the help of an injection of liquidity from the Fed, and which were not and would need to remain closed. Just as Bernanke would do after the 2008 financial crisis—in the form of the so-called Quantitative Easing program—the Fed injected capital into struggling banks by buying assets from them. The Fed paid full price for Treasury securities held by the banks and less than full price for other assets, such as the bonds of railroad companies and retailers, giving the solvent banks the much-needed cash to meet the demands of their depositors. National and state banks could reopen only after being licensed by the Treasury.

Initially other nations were content to wait for the U.S. response, but now I see nations like China, Russia and Germany increasingly willing to act on their own. The trend in the amount of global trade priced in dollars has been going down for decades. This brings us today to the key question, which is what is the U.S. plan? Fed Chairman Bernanke wakes up every morning and tries to trash the dollar with quantitative easing, zero interest rates and swaps lines with the central banks. But it has not been working. The Fed has never taken it to the next step and asked what happens when quantitative easing does not work.15
Americans face a decision as we approach an inevitability: One day the other nations such as China and the EU will want an equal share of the global monetary franchise that has belonged solely to the United States since WWII. As Nouriel Rubini said in his book Crisis Economics,16 Adam Smith and other economists spent their time focused on why markets work, not why they falter.